Small-cap stocks are on the rise! The Russell 2000 Index rose 4% in Q3, outperforming the S&P 500 Index

According to the Zhitong Finance and Economics APP, despite suffering more severe impacts in September than large-cap stocks, US small-cap stocks outperformed the S&P 500 Index in the third quarter.

Liz Ann Sonders, Chief Investment Strategist at Charles Schwab (SCHW.US), stated in a phone interview on Thursday, "Overall, the Federal Reserve clearly indicated at the end of August during the Jackson Hole Economic Symposium that it will adopt a looser policy, which has boosted small-cap stocks." She explained, "Small-cap stocks typically perform well in a rate-cutting cycle, especially when the Federal Reserve cuts rates to prepare for economic recovery in response to a recession."

However, Sonders also pointed out, "We are not currently in an economic recession." Despite the economic slowdown, she added, "The economic performance is still good."

According to FactSet data, the benchmark for US small-cap stocks, the Russell 2000 Index, rose by 4% this quarter, although it has fallen by 4% as of Thursday this month. In comparison, the S&P 500 Index only rose by 2.5% in the third quarter, but the S&P 500 Index has significantly outperformed small-cap stocks so far this year.

Investors expect the Federal Reserve to announce a start to lowering its benchmark interest rate, which has been at a high level since July 2023, after Wednesday's policy meeting. The Federal Reserve had previously raised rates to combat soaring US inflation, which has significantly fallen back to near the 2% target after peaking in 2022.

According to CME FedWatch tool data, as of Thursday, traders in the federal funds futures market expect a 69% probability that the Federal Reserve will cut the policy rate by 25 basis points at this meeting, to a target range of 5% to 5.25%.

For investors hoping for a larger rate cut by the Federal Reserve, Sonders cautioned, "Be careful what you wish for." She explained that larger rate cuts typically occur during economic recessions or financial crises.

The recent rebound in small-cap stocks has somewhat "stalled" as traders adjusted their expectations for the rate cut from 50 basis points back to 25 basis points. Sonders stated that this "may trigger profit-taking in small-cap stocks because overall, small-cap stocks tend to benefit more from the magnitude of rate cuts than large companies."

However, Sonders also warned that the small-cap stock market is very large and not "homogeneous." Within the Russell 2000 Index, there is a significant difference in stock performance, with low-quality stocks and high-quality stocks often performing differently.

Sonders pointed out, "The economy is slowing down and has not entered an acceleration phase." Therefore, if investors are looking for opportunities in small-cap stocks, they should "focus on high-quality companies."

The S&P SmallCap 600 Index typically includes higher-quality stocks than the Russell 2000 Index because it uses an "earnings filter." Sonders suggested that investors can use it as a benchmark when screening for investment opportunities On Thursday, small-cap stocks outperformed the S&P 500 index. The Russell 2000 index rose by 1.2%, while the S&P Small Cap 600 index also rose by 1.2%, both outperforming the 0.7% increase in the S&P 500 index.

On Thursday, the U.S. stock market generally rose, with the blue-chip Dow Jones Industrial Average rising by nearly 0.6%, and the tech-heavy Nasdaq Composite Index rising by 1%. As of 2024, the S&P 500 index has accumulated a 17.3% increase, far exceeding the slightly over 5% increase in the Russell 2000 index year-to-date, despite a poor performance in September. According to FactSet data, the S&P 500 index fell by 0.9% as of Thursday this month, while the Russell 2000 index fell by 4% in September