“Small Caps Soar: Is Wall Street’s Favorite Trade Making a Comeback?”

The small-cap Russell 2000 index has finally taken the lead in the stock market rally after months of underperformance. This surge comes on the heels of a better-than-expected June inflation reading, which has fueled optimism about potential Federal Reserve interest rate cuts.

Over the past month, the Russell 2000 index has gained about 8%, significantly outpacing the S&P 500’s less than 1% increase during the same period. However, the rally hit a roadblock on Thursday as the Russell 2000 dropped more than 2%, extending losses from the previous trading session.

Wall Street strategists are now debating whether this rally has more room to run. UBS Investment Bank’s Maxwell Grinacoff believes that the rotation into low-quality stocks could continue if rate cuts remain priced in and the “Trump 2.0 trade” persists ahead of the US elections. Grinacoff emphasized that further cooling in inflation and strong economic data will be key factors in sustaining the rally.

The recent surge in small caps has been historic, with the Russell 2000 rising more than 11% in just five trading days following the latest inflation data. This rapid increase, driven by expectations of a Fed rate cut in September, marked the largest outperformance of the S&P 500 in a five-day period on record.

Bank of America’s Savita Subramanian believes that the trend in small caps is likely to continue, but she cautions against blindly investing in the Russell 2000 index. Subramanian pointed out that a significant portion of the index is unprofitable and faces higher refinancing risks due to elevated interest rates compared to the S&P 500.

While Subramanian sees potential for a comeback in valuations, she remains cautious about areas of the index with greater refinancing risk or credit sensitivity. These sectors may still face challenges until the Fed actually begins cutting rates.

Overall, the small-cap rally has caught the attention of investors and analysts alike, signaling a shift in sentiment and potentially more gains to come. As the market continues to digest economic data and Fed policy signals, the future trajectory of small caps remains uncertain but promising.

In conclusion, the recent surge in small caps has injected new life into the stock market rally, but uncertainties remain as investors navigate changing economic conditions and Fed actions. Stay tuned for further developments as the market continues to evolve.