Small-cap stocks, represented by ETFs like the iShares Russell 2000 ETF (IWM), are known for their sensitivity to interest rate fluctuations. Historically, following Federal Reserve rate cuts, all market cap sectors tend to rally, with small caps often outperforming their larger-cap counterparts. This outperformance stems from small-cap companies’ heavier reliance on external financing. Lower borrowing costs, a direct result of rate cuts, create a favorable environment for small-cap companies, making it easier for them to secure capital for growth and operations.
Earlier in 2024, small caps underperformed large caps due to delays in expected rate cuts, resulting in a substantial performance gap between the two. However, with the recent 50 basis point rate cut, the landscape is poised to shift. The valuation of small-cap stocks remains attractive, presenting an opportunity for investors to capitalize on a potential rebound. Moreover, the fourth quarter traditionally witnesses strong performance from small caps, creating a seasonally favorable environment for them to catch up to the broader market.
The IWM, tracking the performance of 2,000 small-cap U.S. stocks, has recently outperformed the broader market and the tech-heavy Nasdaq. This month alone, the IWM has gained nearly 4%, significantly outpacing the S&P 500 and the tech sector. This strength follows the ETF’s break above a multi-year resistance level in July. After a brief pullback, the IWM successfully turned the previous $210 resistance area into a newfound support level. This shift signifies increased buyer support at higher price levels, indicating a potential change in momentum. The recent 50bps rate cut has further boosted market sentiment, reinforcing the IWM’s relative strength. The ETF is currently trading just 3.4% below its 52-week high.
Considering its lagging year-to-date performance compared to larger-cap stocks, the IWM appears well-positioned for a breakout as we approach the year’s final quarter, a historically strong period for small caps. This presents a prime opportunity for small-cap stocks to play catch-up and deliver impressive returns.
How to Gain Exposure to Small-Cap Stocks
The First and Obvious Choice: IWM
The iShares Russell 2000 ETF (IWM) is the go-to option for investors seeking broad, diversified exposure to small-cap stocks. Tracking the Russell 2000 Index, which includes approximately 2,000 small-cap companies across the U.S., the fund boasts a market cap exceeding $70 billion. This provides investors with exposure to a wide range of industries, including financials (18.8% of the portfolio), consumer discretionary (10.8%), and healthcare (10.6%). The ETF offers a dividend yield of 1.2% and has a low expense ratio of 0.19%. Analysts have assigned the ETF a Moderate Buy rating, with a consensus price target of $231.75, indicating nearly 5% upside potential.
For Risk-Tolerant Investors: TNA
Direxion Daily Small Cap Bull 3X Shares (TNA) presents an attractive option for investors seeking amplified returns, provided they are willing to accept elevated risk. This leveraged ETF aims to deliver 300% of the daily performance of the Russell 2000 Index, meaning a 1% move in the index translates to a 3% return for TNA. However, this higher reward potential comes with increased risk. The ETF has a market cap of $2.74 billion, an expense ratio of 1.08%, and a small dividend yield of 0.23%. Year-to-date, TNA is up over 11%, consolidating below its 52-week high. A key resistance level to watch is the $50 area, which has served as a significant inflection point for the ETF. A breach of this level could signal a potential breakout.
