Wall Street Veteran Voices Confidence in Undervalued Small-caps and Forecasts a 50% Rally in 2024

Tom Lee, co-founder of Fundstrat Global Advisors, is casting his gaze towards small companies as the candidates for superior returns in the upcoming year.

Lee predicted the Russell 2000 index, which tracks U.S. stocks with an average market capitalization of just $2.8 billion, could rise from 1,996 to 3,000 by year-end.

Lee's optimism hinges on two key economic indicators: inflation and interest rates. He notes that a significant portion of core inflation—which excludes the more fluctuating costs of food and energy—is driven by the housing market and the automotive sector, both of which are not experiencing the dramatic price increases seen in the recent past. Lee contends that if housing inflation levels off at 6% and automobile prices persist in their decline, overall inflation could meet the Federal Reserve's 2% goal and remain there in 2024.

If inflation continues to fade in 2024, leading the Fed to cut interest rates as is now widely forecast, that could be a boon for small-caps that have been hit the hardest by rising borrowing costs.

There are plenty of smart people on Wall Street pushing the same message. Royce Investment Partners co-chief investment officer Francis Gannon said "Small-caps are [still] cheap from a valuation perspective. They have priced in a recession that has yet to materialize."

For investors, this means small-caps that will benefit most from interest rate cuts present opportunity, especially given how cheap they are compared to larger peers. Historically, small-caps have traded at a premium to large-caps, but that has been flipped on its head in the post-COVID world and are close to multi-decade lows on valuations. Now the question is when will it revert.

Despite the impressive climb in stocks, David Donabedian, chief investment officer of CIBC Private Wealth US warned there were "lingering concerns about valuations and ultimately a scenario that may be too rosy" as the recent rally has investors pricing in the perfect soft landing for the economy, without the pain of a recession.