Small cap stocks could take the spotlight in 2024 if the Federal Reserve follows expectations with a dovish stance amidst a robust economic backdrop.
In 2023, there was a notable rally in small-cap stocks, many of which outpaced their larger counterparts.
As the year draws to a close, investors are preparing for a significant rally in small-cap stocks. The recent December surge in the Russell 2000 and the potential for continued gains in the new year has led to bullish forecasts, such as a 50% climb in small-cap stocks over the next 12 months.
Now, Wall Street is largely anticipating the Fed to ease monetary policy in 2024.
In November, the Russell 2000 index, reflective of smaller market players, witnessed an uptick in its forward P/E ratio from 12.3x in October to 13.5x, marking its highest level since February.
Small-cap stocks have maintained a 12% discount compared to their long-term average. In contrast, mid and large-cap counterparts are experiencing premiums of 5% and 21%, respectively, with mega-caps leading at a 27% premium. Notably, even when accounting for underperformers and outliers, the Russell 2000 remains below its average.
For investors with a long-term horizon, these statistics suggest potential annualized price returns of 11% over the next decade for the Russell 2000, surpassing the 3% per annum estimate for the Russell 1000. This implies that, based on current valuations, smaller companies might offer more favorable long-term returns.
Traditionally, small caps face challenges in the wake of interest rate cuts, but in the coming year the prospect of an early dovish shift might trigger a cyclical rebound in nominal growth, making small caps attractive for long-term investors.
Markets are experiencing the unique conditions of a solid economy, controlled inflation, and a robust job market could see the Fed cutting rates to declare victory over inflation. This bodes well for small-cap stocks, as lower interest rates generally translate to reduced capital costs—a significant advantage for smaller firms burdened with higher borrowing costs relative to larger counterparts.
Small cap stocks offer potential for profit due to share price appreciation and stability from established business models. However, there are drawbacks, like susceptibility to market manipulation and challenges in a slow economy due to modest balance sheets. Then there is the potential impact of prolonged higher rates on small-cap companies, which often rely on credit.
Equities with historically attractive valuations, potential outperformance post-recession, little-owned asset classes, and sector-specific opportunities in technology, industrials, and healthcare stand to benefit most.
The stage is set for a potentially transformative year for small-cap stocks in 2024.
Small cap stocks to watch in 2024
e.l.f. Beauty, Inc. (NYSE:ELF)
The NYSE-listed beauty company started the year trading at around US$55 and ended at over $145, marking a 161% increase over the 12-month period. That’s largely due to contribution from a faster-growing skin care category and an underappreciated runway for international growth, according to analysts at UBS, who still believe that e.l.f. is in the “early innings” of a bottom-line inflection story after years of cost headwinds and increased spending.
Soleno Therapeutics Inc
The biotech company had a great year, with its share price gaining nearly 2,000% after its lead candidate, diazoxide choline extended-release tablets (DCCR), saw great success in the treatment of Prader-Willi syndrome (PWS).
Sigma Lithium Corp (TSX-V:SGML, NASDAQ:SGML)
The Brazil-focused lithium producer got the rumor mill churning earlier this year when reports broke that Tesla was considering acquiring the company to access its Quintuple Zero Green Lithium. Since then, the NASDAQ-listed firm has navigated a rocky lithium market better than most of its peers, finishing the year with gains of around 14%.
Vivos Therapeutics (NASDAQ:VVOS)
This small cap medical device company’s shares shot up a stunning 800% in November after news broke that it had received FDA clearance for its removable CARE (Complete Airway Repositioning and/or Expansion) oral appliances to treat severe obstructive sleep apnea (OSA) in adults. The unprecedented FDA clearance created a stir in the markets, with over 40 million shares traded. Vivos is now positioned as the first company to offer an FDA-approved alternative treatment to CPAP or surgical neurostimulation implants for patients with severe OSA, opening new revenue opportunities.
Carvana Co. (NYSE:CVNA)
One of the top small cap performers of 2023, the online used car retailer’s stock gained a remarkable 1,085% throughout the year. But that has led some analysts to hit the stock with a Sell rating, considering Carvana’s shares overvalued. Nevertheless, this is one to keep an eye on.