A Record Run is About to End Three Years of Futility for Small-cap Stocks - if It Holds

Small-cap stocks surged on Monday, nearing a record high and heading toward their most significant monthly gain of 2024. Investors are positioning for the final trading days of November in a holiday-shortened week due to Thanksgiving.

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Russell 2000 Performance

The Russell 2000 index (RUT), which tracks U.S. small-cap equities, has advanced 11.2% so far this month. According to FactSet data, this places it on track for its largest monthly increase since December 2023. This recent performance helps small-cap stocks narrow the gap with the S&P 500 (SPX), which has seen a strong year-to-date rise.

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While the S&P 500 has gained 4.9% in November, the Russell 2000’s impressive growth has surpassed it, signaling increased investor interest in smaller domestic companies. Much of this momentum is attributed to optimism surrounding President-elect Donald Trump’s anticipated pro-growth policies, including tax cuts that could benefit sectors tied closely to the U.S. economy.

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Small-Cap Sector Dynamics

Small-cap stocks are concentrated in sectors considered "domestically focused" and "economically sensitive," according to Dan Lefkovitz, a strategist with Morningstar Indexes. These include financial services, basic materials, consumer cyclicals, and real estate—industries expected to perform well under Trump’s policy agenda.

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Following the November 5 election, Jefferies analysts highlighted that the sustainability of the small-cap rally could hinge on the direction of interest rates. Lower rates tend to favor smaller companies by reducing borrowing costs and increasing their appeal relative to larger, more stable firms.

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Treasury Yields and Small-Cap Surge

On Monday, the bond market saw a drop in yields, which contributed to the small-cap rally. The yield on the 10-year Treasury note fell 14.7 basis points to 4.262%, marking its largest daily decline since early August, based on Dow Jones Market Data. The decline in Treasury yields, which serve as a benchmark for valuing equities, provided a tailwind for small-cap stocks.

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As a result, the Russell 2000 gained 1.5% on Monday to close at 2,442.03. This performance outpaced the modest 0.3% rise in the S&P 500. The Russell 2000 is now just shy of its record close of 2,442.74 set on November 8, 2021, according to Dow Jones Market Data. In contrast, the S&P 500 has reached several record highs this year, with its most recent peak on November 11, marking the 51st record close of 2024.

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Historical Trends Favor December Gains

Historical data suggests the Russell 2000 may continue its upward trajectory in December. According to Dow Jones Market Data, the index has historically delivered its strongest average monthly performance in December, with a 2.8% average gain. This exceeds the December averages for the S&P 500, the Dow Jones Industrial Average (DJIA), and the Nasdaq Composite (COMP).

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Despite its recent momentum, the Russell 2000 still lags the S&P 500’s year-to-date rally of 25.5% by approximately five percentage points. However, certain exchange-traded funds (ETFs) focused on small-cap growth stocks have performed exceptionally well, narrowing the gap with larger benchmarks.

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Small-Cap Growth ETFs Keep Pace

The Vanguard Small-Cap Growth ETF (VBK), which tracks an index of U.S. small-cap growth stocks, has gained 24.8% in 2024 through Monday. Similarly, the iShares Russell 2000 Growth ETF (IWO) has risen by 24.7% over the same period, according to FactSet data. These ETFs reflect the broader enthusiasm for growth-oriented small-cap equities, which are poised to benefit from favorable economic policies and improving market conditions.

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Broader Market Context

The recent rally in small-cap stocks comes as the broader U.S. stock market remains resilient. Investors continue to weigh the implications of Trump’s policies, interest rate trends, and economic data releases. With the Thanksgiving holiday closing markets on Thursday, trading volumes may remain subdued for the rest of the week, but small-cap stocks appear poised to finish the month strong.

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In summary, small-cap stocks have seen a remarkable resurgence in November, driven by optimism over pro-growth policies, a favorable interest rate environment, and sector-specific dynamics. The Russell 2000’s performance highlights the growing investor appetite for smaller, more domestically focused companies, setting the stage for potential gains as the year-end approaches. With historical trends favoring strong December performance and ETFs reflecting sustained interest in small-cap growth, the sector remains a focal point for investors seeking diversification and growth opportunities.

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