Small caps are on pace to notch their third record close for the year, but many expect the asset class is due for further gains ahead. Small caps have been on a tear recently. On Monday, the Russell 2000 small cap index topped 2,500 for the first time ever, an all-time high for a benchmark that’s up more than 12% this year. The benchmark was bolstered by rare earths miners, small-scale nuclear names and crypto-connected equities. That comes after the index last month took out its prior record high from November 2021, a notable milestone that has many investors thinking the asset class could finally break out after years of underperformance. “I do think small caps are cheap,” Marta Norton, chief investment strategist at Empower. She likened the current rally to the one in Chinese large cap tech, which has outperformed this year after several years of underperformance in spite of calls for cheap valuations. “I think you want to say, ‘I want this upside potential,'” Norton said. “I don’t know when it’s going to work out, but I’d like to have it in my portfolio alongside things that have zero margin of safety from a valuation standpoint.” .RUT YTD mountain Russell 2000, year to date There are reasons to be bullish on the rotation. The Federal Reserve is expected to cut interest rates at its remaining two meetings of the year, in October and December, a boon for smaller companies that are sensitive to borrowing costs. Meanwhile, the economy continues to expand, while inflation remains relatively tame, allaying the worst of investors’ fears that cyclical assets could take a hit. That could mean the Russell 2000 has further upside through the end of the year, according to Jeff Kilburg, investment chief at KKM Financial. He noted that the Russell 2000 has the added advantage of being composed of many mid-cap companies, a market cap size that he feels could especially benefit going forward. “That type of dispersion could be the way to be positioned going into not just the end of the month, end of the quarter, but potentially the end of the year,” Kilburg said. To be sure, he also added that small caps could run out of momentum eventually. Citi Research’s Scott Chronert recently updated his “Value Creators” small- and mid-cap recommended list, adding Penske Automotive and Flowserve , while removing Gap and Chart Industries following downgrades. Here are five stocks the firm likes. For investors with a longer-term mindset, small caps are too cheap to ignore, according to Empower’s Norton. “You want to position for the possibility that small caps have a much brighter future and that the economy is stronger than it looks because there’s also that upside possibility,” Norton said. “One thing that we’ve been talking about is, from that range of outcomes perspective, the tails are fatter.” “Small caps can do much better than they have been,” she added. — CNBC’s Nick Wells contributed to this report.
