The Russell 2000 index has broken historical records, and the 2,500-point target is just around the corner.

Higher-risk stocks have taken the spotlight, and the Russell 2000 is set to achieve its first record close in three years. This rebound was long overdue and has the potential for further gains.

Although it ultimately ended flat, the Russell 2000 came close to the November 2021 high of 2,442.74 points for part of Monday, having initiated a breakout last week. It ended November with an 11% increase, outperforming the S&P 500 and the Nasdaq Composite Index. Strong economic growth in the U.S., reasonable valuations, and expectations of interest rate cuts suggest that the 2,500-point threshold for this index should be within reach.

Small-cap stocks have recently benefited from Trump's election as president, reinforcing the 'America First' ideology. Approximately 80% of the revenue for companies in the Russell 2000 index comes from domestic operations, and Trump's anti-trade stance and dollar-dominance policies have boosted investor sentiment in this sector.

The rationale for breaking the 2,500-point barrier comes from a report by Oanda broker on Monday morning, which Kelvin Huang referred to as 'key mid-term resistance for E-mini Russell 2000 futures.' This level is often seen as a psychological barrier in technical analysis, usually indicating expected trend formation.

The driving forces supporting the small-cap index appear to be stronger than the resistances. The Russell 2000 is currently experiencing its third-longest period in history without a record close, while the S&P 500 has recorded 54 record closes this year.

Optimism also stems from expectations of interest rate cuts, which are crucial for small businesses. Due to the high debt characteristics of small businesses, they are more reliant on low interest rates to manage expenses. According to data from CME Group, the market widely expects the Federal Reserve's benchmark interest rate to fall to a range of 3.75% to 4% by 2025. Morgan Stanley predicts rates will drop to a range of 3.5% to 3.75%, while Goldman Sachs forecasts a final target range of 3.25% to 3.5%. Deutsche Bank is an exception, expecting only a 0.25-point cut, reducing the current 4.5%-4.75% to 4.25%-4.5%.

If the rate cuts exceed expectations, small-cap stocks, being more sensitive to interest rate changes, will outperform the large-cap market. According to UBS analyst Jonathan Golub's report on Monday, over the past year, when expectations for rate cuts increased, the average daily return of profitable companies in the Russell 2000 index was 0.21%, while non-profitable companies had a return of 0.44%. In comparison, S&P 500 companies had an average return of 0.16%.

Although expectations for interest rate cuts in 2025 have not materialized, there is already strong optimism about economic growth next year. Forecasters surveyed by the Philadelphia Fed expect an economic growth rate of 2.2% in 2025, slightly lower than 2.7% in 2024, but still robust. Lower interest rates and strong economic growth create an ideal environment for small-cap stocks, as they are more sensitive to economic conditions.

Investors can also find some comfort in JPMorgan's report on Monday, which mentioned that the company still maintains an overweight position in U.S. small-cap and mid-cap stocks, partly due to 'increased demand for the U.S. market and the lack of upside potential for large-cap stocks at current valuation levels.' Goldman Sachs expressed a similar view last month.

Currently, the price-to-earnings ratio of the iShares Russell 2000 ETF is 27.23 times, compared to the 28.25 times of the iShares S&P 500 Growth ETF, which primarily invests in large-cap companies.

The iShares Russell 2000 Fund has performed well recently, rising 20% this year, although growth funds have increased by 38%, and the broad market (as measured by the SPDR S&P 500 ETF) has risen by 28%. Next year could be even better.

Article reposted from: Jin Shi Data