In the past five days, the "historic surge" in small-cap stocks in the US stock market, can it be sustained?

Over the past week, small-cap stocks in the US have performed strongly, hitting historic highs and outperforming large-cap stock indices.

On the day when US inflation data was released, the Russell 2000 Index rose by 3.6%, marking its best single-day performance since October; over the past five days, the index surged by 11.5%, reaching a new high in 2024. This rally far exceeded market expectations and surpassed the performance of large-cap and tech stocks.

Analysts believe that the reasons behind this surge in small-cap stocks are as follows:

Investors generally expect a rate cut by the Federal Reserve. Interest rate futures indicate a high likelihood of the central bank cutting rates at the September policy-setting committee meeting. The market widely expects the Fed to take rate-cutting measures to stimulate economic growth, which is usually favorable for small-cap stocks as it significantly reduces their borrowing costs.

"Trump Trade": With the increased likelihood of former US President Trump winning re-election, investors anticipate a reduction in corporate income tax rates, possibly from the current 21% to 15%, which also benefits small-cap companies.

Rotation out of tech stocks: The market believes that the stock valuations of tech giants like NVIDIA are too high and the rally may be coming to an end, prompting investors to shift towards undervalued small-cap stocks.

Is this trend sustainable?

Analysts have differing views on the future trend of small-cap stocks.

Some analysts believe that the recent outstanding performance of small-cap stocks is not based on significant changes in the business of small-cap companies, and their earnings or revenue have not increased significantly. The rally may be driven by market sentiment influenced by changes in tech stocks, lacking substantial fundamental support, thus posing a certain risk of a bubble.

Chris Senyek, Chief Investment Strategist at Wolfe Research, wrote:

Better-than-expected earnings and positive financial forecasts are the reasons to double down on investing in this industry before the year-end.

Furthermore, small-cap stocks also face a key issue: their ability to benefit from factors like rate cuts has weakened. Dennis DeBusschere of 22V Research stated:

The rate cut brought by a soft landing has reached its maximum. The rate cut will be even greater in a hard landing.

Small-cap stocks have seen the largest surge in history over the past five days, and they may have already priced in all the positive news. This means that from now on, the pace of returns should slow down.

Garrett Melson, Portfolio Strategist at Natixis Investment Managers Solutions, mentioned that he is not currently considering chasing this rally. Historically, small-cap stocks rose before the Fed began a series of rate cuts in 1995, but as economic growth began to slow down, the rally did not continue

I do believe that in the coming months, we should pay more attention to the growth prospects of technology stocks.

UBS's Patrick Palfrey is optimistic as he expects the earnings of large-cap stocks to deteriorate, requiring continuous efforts for small-cap stocks to catch up.

Some analysts hold a neutral stance on small-cap stocks. LPL Research analyst Adam Turnquist pointed out:

It is expected that the growth of small-cap stocks will face greater challenges, as they are more sensitive to the economic health conditions compared to the value of small-cap stocks.

If long-term high-interest rate policies are implemented, some small-cap stocks (mainly regional banks) may continue to benefit from the rise in loan rates