After a long period of underperformance, the Russell 2000 finally seems to be showing signs of life. A potential easing of monetary conditions has been a positive catalyst this month, amplified by attractive valuations. It is likely that small cap fundamentals will become a greater focus ahead, and whether earnings will deliver without relying on Tech momentum. As such, economic resilience is likely key for a sustained small cap rally.
The last time the Russell 2000 reached a record high was in November of 2021, compared to just this month for the S&P 500. Indeed, the tech-heavy S&P has driven this cycle’s momentum, pushing the valuation gap between both indices to decade highs. Now, with such attractive valuations on offer and the strong likelihood of a Fed cut in September, small caps have again caught investors’ attention.
So far this month, the Russell has outpaced the S&P by nearly 5%. Whether this will be a short-lived bounce or a sustained rally for small caps depends on having enough catalysts to support earnings growth ahead. With the Russell 2000 unlikely to benefit from the same AI tailwinds as the S&P 500 (given the tech sector’s smaller weight in the index), a durable rally instead likely rests on:
- Economic resilience: a convincing rebound in leading economic indicators
- Preemptive rate cuts: aimed at stimulating growth rather than easing distress
- Supportive fiscal and regulatory policies: tax cuts and lower regulatory costs improve earnings
- Tariff policy clarity: negotiations or further visibility about the trade environment
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