Wall Street is betting on America’s smallest public companies to take the lead. The Russell 2000, a benchmark packed with companies few retail traders ever touch, has jumped nearly 10% since late July, doubling the gain in the S&P 500.
That outperformance has caught the attention of strategists, who now expect this rally to keep going well into 2026.
Projections gathered from stock price targets now show analysts expect the Russell 2000 to gain another 20% over the next year, while the S&P 500 is only expected to rise about 11%.
Since 2020, smaller stocks have underdelivered every single year. Even with the latest surge, the Russell still lags behind the S&P in 2025. But this call is tied to rate cuts, earnings surprises, and a hope that the economy holds strong enough to help smaller firms catch up.
Fed cut bets push small caps ahead
Michael Casper, senior U.S. equity strategist at Bloomberg Intelligence, said smaller companies are “the most sensitive to the U.S. economy.” He believes Federal Reserve rate cuts could boost margins and change the game. “All of a sudden, consensus starts to show some love toward small cap companies,” he said.
Markets responded fast last Thursday after inflation and jobs numbers landed in line with expectations. With signs that the labor market is cooling off, traders ramped up bets that the Fed will lower interest rates next week and likely again before the end of 2025. That same day, the Russell 2000 jumped 1.2%, while the S&P 500 added 0.7%.
Morgan Stanley’s Michael Wilson said in a research note Monday that upcoming Fed cuts could launch a new leg of the bull market and push small caps higher. He upgraded his view from underweight to neutral earlier this month. Still, he wants to see stronger momentum in earnings revisions before going fully overweight.
That momentum may already be forming. Second-quarter earnings beat expectations for over 60% of Russell 2000 companies, and revenue results came in 130 basis points above forecasts on average. That beat rate is raising confidence that earnings growth is finally supporting the rally in small caps.
Tom Hainlin, national investment strategist at U.S. Bank NA, said in an interview that the combination of earnings beats, cheaper valuations, and expected policy easing is “a pretty good collection of things for mid- to small-caps rally.”
Low valuations attract institutional buyers
Emily Roland and Matt Miskin, co-chief investment strategists at Manulife John Hancock Investments, said that unlike large-cap names, small caps and mid-cap value stocks are not trading above their 20-year averages. They called the group “underappreciated” and pointed out it’s one of the few spots still sitting at a discount.
Since the rally picked up in August, the Russell 2000’s price-to-earnings ratio has moved above its historical average. But Jill Carey Hall, equity and quant strategist at Bank of America, said that’s not a red flag.
“Small caps are no longer cheap vs. history, but remain the least-stretched size segment and still trade at a wide historical discount to large caps,” Jill wrote in a note this week. She added there’s “potential for a further re-rating.”
Options data from Cboe Global Markets also shows a tilt in sentiment. Investors are placing more bullish positions on the Russell 2000 than the S&P 500. Mandy Xu, vice president and head of derivatives market intelligence at Cboe, said the pattern reflects investor exposure.
“This makes sense as investors buy protection where they have exposure,” like in large caps, “and upside calls where they are underweight and where they see potential for catch-up,” Mandy said.
Flows into small cap ETFs have also flipped positive. Lori Calvasina, head of U.S. equity strategy at RBC Capital Markets, said in a note that inflows into small caps have picked up. But she added a warning: the rally still needs signs that the economic backdrop is moving out of sluggish mode.
She said the space has seen this before, since COVID, there’ve been multiple short rallies, only to be flattened by stronger moves in tech and large caps.
Still, Barclays analysts are telling investors to lean into both tech and small caps, especially those showing strong earnings momentum. They wrote in a Wednesday note, “Small caps are a big deal.”
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Source: https://www.cryptopolitan.com/wall-street-bullish-on-riskiest-stocks/