Small Cap Stocks Have Been Lifted by Unprofitable Companies. Can They Continue Climbing?

Core Insights - The U.S. stock market is experiencing a speculative rally, particularly in small-cap stocks, driven by expectations of interest rate cuts [2][4] - The Russell 2000 index has outperformed the S&P 500 since April, with unprofitable companies in the index seeing a 19% increase compared to a 9% gain for profitable firms [3][7] Small-Cap Performance - The Russell 2000 index has reached record highs this week, fueled by optimism regarding interest rate cuts that could benefit small companies [2][4] - The S&P 600 index, which requires positive earnings, has only increased by about 2% this year, indicating a disparity in performance among small-cap stocks [3] Investor Sentiment - Investor enthusiasm for small-cap stocks is based on the belief that they will deliver stronger earnings growth after two years of stagnant profits [5] - Fund managers argue that small-cap valuations remain attractive, with the Russell 2000's market capitalization at 4.4% of the Russell 3000, below the historical average of 7.6% [6] Valuation Metrics - Small-cap valuations compared to large-caps are near 25-year lows, suggesting potential for growth [6] - The estimated earnings growth for the Russell 2000 in 2025 is projected to exceed 25%, significantly higher than the Russell 1000's expected 10% growth [6]