Small stocks, big comeback

You might not have noticed, but small-cap stocks are having a big moment.

The trend is an easy one to miss: Tiny stocks haven’t been getting a lot of love over the past year, as flashy tech names hogged the spotlight. But Tuesday’s inflation report, which showed that tariffs haven’t significantly re-stoked inflation (yet), changed that narrative.

The CPI reading provided more solid data that could support the Federal Reserve cutting rates in September, which would pour fuel onto the economy and give a boost to rate-sensitive stocks—like small-caps. As of now, traders are pricing in a 92.6% chance of a rate cut at the Fed’s next meeting.

In the days since the CPI report arrived, investors have been pouring money into all kinds of riskier assets, particularly small caps. Just look at the Russell 2000 index, which has gained 3.42% over the past week and hit its highest level since December yesterday.

Are small caps the path to large gains?

For value investors, there are real bargains to be found looking past the biggest stocks in the S&P 500.

Bank of America analyst Jill Carey Hall explained that some of the best deals on the market today are in the small caps. She pointed to small caps in the energy, communications, and financial sectors, which are “broadly the most inexpensive vs history.” On the flip side, small cap tech, industrials, and utilities are some of the most expensive compared to history. Excluding healthcare and staples, most small-cap sectors trade at a discount when compared to their large-cap counterparts, according to Hall.

But…today’s PPI report showed that prices have indeed been accelerating faster than expected, complicating the narrative Tuesday’s numbers depicted. There’s no guarantee that this year’s rally is going to suddenly broaden out to even the smallest of companies.

The truth is that nobody knows for sure if small-caps are strong picks, not even the pros.

“Currently, over a tactical time frame of up to one year, we maintain a neutral weight to small-cap growth and an underweight to small-cap value, as potential economic weakness can prove to be a headwind,” explained Chief Equity Strategist for LPL Financial Jeff Buchbinder.

On the other hand, here’s what Royce Investment Partners co-CIOs Francis Gannon and Chris Clark have to say: “Amid the difficulties of volatile markets and periods of economic uncertainty, we also think it’s crucial to remind investors of the opportunity to build their small-cap allocation at attractively low prices,” they wrote. “We continue to see the currently unsettled period as an opportune time to invest in select small-caps for the long run.”—LB