Powell's dovish tone boosts, U.S. small-cap stocks rebound strongly! Bank of America and UBS join the bullish camp

According to the Zhitong Finance APP, U.S. small-cap stocks have previously boarded the "rotation train of funds flowing out of large technology stocks and into stagnant market sectors," and the dovish signals released by Federal Reserve Chairman Jerome Powell last Friday have injected more momentum into this rebound. Strategists from Bank of America (BofA) and UBS Group AG both hold this view, believing that Powell's signal of "potential rate cuts as early as next month" at the Jackson Hole annual meeting provides optimistic support for small-cap stock performance.

Bank of America equity strategist Jill Carey Hall wrote in a report to clients on Monday, "Unless there are significant tariff announcements or other macro surprises, we believe the Russell 2000 Index (small-cap benchmark) may outperform large-cap stocks in the coming weeks."

UBS also echoed this view, with strategists including Sean Synder pointing out that "as rate cuts alleviate balance sheet pressures, small-cap and low-quality stocks may continue to outperform large caps." Over the three weeks leading up to last Friday, the Russell 2000 Index rose a cumulative 9%, while the Nasdaq 100 Index (dominated by large-cap tech stocks) only increased by 3.2% during the same period.

UBS strategists mentioned that since bottoming out in early May, the earnings revisions of Russell 2000 constituent companies have significantly increased, consistent with the index's rebound trend. In the previous months, the small-cap sector had lagged behind the overall stock market and had not reached a historical high since November 2021.

Last Friday, Powell's dovish remarks convinced traders that a rate cut was "almost a done deal," leading to a 3.9% single-day surge in the Russell 2000 Index, marking its best single-day performance since early April. Investors quickly reacted, with the funds injected into the iShares Russell 2000 ETF (the main ETF for small-cap stocks) reaching the highest level since November of last year. Before a slight decline of 1% on Monday, this small-cap benchmark index's performance relative to the Nasdaq 100 Index achieved the best weekly level since July 2024.

Lori Calvasina, head of U.S. equity strategy at RBC Capital Markets, noted in a report that "after the Jackson Hole meeting, small-cap stocks have finally broken out of their consolidation," focusing on Powell's speech at the meeting. She stated that driven by investor position adjustments and some funds flowing out of large tech stocks, the small-cap sector may see a rise in the short term.

However, Calvasina emphasized that in the long run (compared to large-cap stocks), she maintains a "neutral" stance. "Small-cap stocks may face the risk of 'short-term outperformance followed by a rapid end to the rally,' especially if the economic concerns that 'open the door' for a September rate cut ultimately materialize," she wrote.

Hall from Bank of America stated that she is paying attention to the non-farm payroll report to be released next week, which will provide further support for a September rate cut; in addition, whether small-cap stocks can continue to rebound also depends on earnings performance, sales trends, and tariff risks. Hall also warned that historically, October is often the worst month for small-cap stocks relative to large-cap stocks.

Truist Financial Corp.'s co-chief investment officer Keith Lerner upgraded the rating of U.S. small-cap stocks from "less attractive" to "neutral" last Friday, citing valuation advantages, improving earnings trends, and more positive technical signals Despite this, the S&P 600 small-cap index has still underperformed large-cap stocks by about 13 percentage points over the past year. Lerner pointed out that, looking at a rolling three-year period, the underperformance of small-cap stocks is approaching extreme levels not seen since 2000, providing investors with a "catch-up opportunity."

However, Jefferies Financial Group strategist Steven DeSanctis wrote earlier this month that so far this quarter, the gap between expected earnings growth and actual earnings growth for small-cap stocks has exceeded 12%, reaching the highest level since the first quarter of 2022