2023 was an extremely challenging year for small-cap stocks, with the Russell 2000 index falling over 25%. However, recent analysis from major financial institutions indicates these stocks may be positioned for a significant rebound in 2024.
Current Environment Sets Stage for Small-Cap Comeback
Several factors have aligned that could allow small-cap stocks to outperform the broader market this year.
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Attractive Valuations – After substantial declines last year, many small-caps now have very reasonable valuations and upside potential. Goldman Sachs recently identified a group of small-caps with average upside of over 80% to their price targets.
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Improving Economic Backdrop – Fears of an impending recession have eased recently. If global growth stabilizes and the Fed pauses interest rate hikes, it would provide a supportive backdrop for more economically sensitive small-cap companies.
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Shift in Market Leadership – Large cap growth stocks led markets higher for years. A rotation back to value stocks with actual earnings could benefit small-caps in 2024.
UBS, Barron’s, Morningstar and other analysts have all published positive outlooks for small-caps this year with these tailwinds in mind.
Top Small-Cap Stocks Positioned to Outperform
Experts have highlighted several attractive industries and individual stocks offering substantial upside potential:
Business Services
This diverse sector contains companies providing essential services to other businesses like staffing, shipping, and technology. Smaller providers in this area offer growth at a reasonable cost.
- ASGN Inc – IT staffing firm with innovative data and software capabilities beyond traditional temp agency model.
- Echo Global Logistics – Tech-enabled shipping brokerage opening up digital freight management market.
Specialty Finance
These firms provide specialty lending and services in areas like equipment leasing, business funding, and consumer finance. Specialty finance has faced pressure but should improve with economy.
- Air Lease Corp. – Leases commercial aircraft with long-term contracted cash flows. Over 80% upside to average price target.
- OneMain Holdings – Consumer lender to non-prime borrowers with good brand recognition and risk management.
| Stock | Description | 2023 Decline | Potential Upside |
|---|---|---|---|
| ASGN Inc | IT staffing firm | -39% | 55% |
| Echo Global Logistics | Digital freight broker | -36% | 90% |
| Air Lease Corp | Aircraft leasing | -30% | 84% |
| OneMain Holdings | Consumer lender | -50% | 75% |
Table showing sample of top small-cap stocks Goldman Sachs identified as substantially undervalued with +75% average upside potential
Recession Fears and Rising Rates Hammered Small Caps
Last year saw mounting macroeconomic challenges that disproportionately impacted small caps and drove severe underperformance of the asset class:
- Recession Fears – With surging inflation and rapidly rising interest rates, most economists predicted an imminent recession. Smaller companies with limited resources can be severely challenged during economic slowdowns.
- Aggressive Fed Policy – The Fed boosted interest rates at the most aggressive pace in 40 years to combat inflation. Higher rates pressure lending activity and borrowing costs key to small business growth.
- Strong Dollar – Dollar strength in 2023 from Fed policy and its safe-haven status created headwinds for small-caps focused domestically. Pressure should ease in 2024 with potential for more balanced monetary policy.
These intertwined economic factors compressed valuations across higher risk assets. But stabilization in growth and inflation data along with a pausing of Fed hikes could spur a violently positive snapback rally in beaten down small-caps.
Merger and Acquisition Activity Could Also Catalyze Gains
Another potential catalyst is increasing merger and acquisition activity, as larger organizations look to acquire innovators and technology at discounted valuations.
Small-cap stocks typically benefit from consolidating industries rolling up competitors. Examples in today’s market include regional banks, healthcare providers, and niche software vendors. These deals unlock immediate value and signal positive sector trends.
A few small-caps flagged as potential M&A targets include cloud communication platform Bandwidth Inc, retirement services provider Paychex Inc, and veterinary diagnostics leader Idexx Laboratories.
If recession concerns continue fading in 2024, deal flow is likely to accelerate – providing an added kicker for small-cap performance.
Key Risks Remain That Could Derail the Rebound
Despite several positive drivers, small-cap investors shouldn’t get complacent. If economic weakness persists longer than expected, it could delay or diminish the anticipated recovery:
- Recession Hits – An actual economic contraction or profit recession dragging into 2024 could certainly sideline a small-cap breakout for now.
- Inflation Re-Accelerates – Early 2023 inflation relief could easily reverse if supply issues flare up again or the Fed has to resume rate hikes.
- Market Leadership Stays Large – Flows concentrating in mega-cap stocks have dominated for over a decade now. Rotations fail to materialize or quickly fade as investors default to giant tech and growth names.
While small-caps look poised for major outperformance versus recent years, these macro scenarios could result in continuation of the recent underwhelming returns.
Outlook Calls for Selectivity Amid Long-Term Positivity
In summary, small-cap stocks appear primed for recovery based on oversold conditions, supportive monetary policy, and rotational tailwinds. Strong stock picking combined with prudent portfolio diversification will be key to maximize gains while minimizing risks.
UBS analysts summed the opportunity well: “There’s good reason to be optimistic for a small-cap rebound in 2024 given current valuations. But investors should utilize active approaches like mid and small-cap funds to tap into the most promising segments that can outgrow through the volatility.”
With risks ever-present in current markets, a reversion still seems the highest probability outcome given how thoroughly the asset class has been battered and bruised. Those able to withstand residual volatility stand ready to be handsomely rewarded for buying this epic dip.
To err is human, but AI does it too. Whilst factual data is used in the production of these articles, the content is written entirely by AI. Double check any facts you intend to rely on with another source.
