Small-cap stocks are gaining traction, with the Russell 2000 Index outperforming major large-cap benchmarks as the week kicks off amid renewed confidence in the U.S. economy, fueled by upbeat economic data released last week.

The iShares Russell 2000 ETF Trust surged past its 50-day moving average on Thursday and extended gains into Monday, buoyed by investor optimism ahead of the Federal Reserve’s Jackson Hole symposium on Aug. 22-24.

Last week's July inflation report removed the last hurdles to a September rate cut. The headline Consumer Price Index (CPI) dropped to 2.9% year-over-year, the lowest since March 2021, indicating a continued easing of price pressures. Additionally, retail sales jumped by 1% month-over-month, the strongest increase since January 2023, indicating that recession concerns were likely exaggerated.

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Chart: Russell 2000 Clears Resistance From 50-Day Moving Average

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Small Caps Positioned Fo Benefit From Lower Interest Rates

The stars appear to be aligning for the first Federal Reserve rate cut on Sept. 18, which would be particularly advantageous for small caps.

“Small-cap companies, in particular, benefit from loose financial conditions,” noted Jason Anderlik, a product specialist at Global X. Unlike large-cap companies that typically have better access to capital markets and established relationships with lenders, small-cap companies often rely more heavily on bank financing, which is typically shorter-term and at floating rates.

A rate cut could have an immediate positive impact on their bottom lines as floating-rate debt would adjust to reflect the lower reference rate. Additionally, looser financial conditions and stronger confidence in the economy could increase the availability of financing, further benefiting these smaller companies, the expert explained.

Small Caps Return To Earnings Growth

After five consecutive quarters of declining earnings, small caps have made a strong comeback in the second quarter of 2024. The Russell 2000's year-over-year earnings growth rate hit 17.9%, according to data from the London Stock Exchange Group as of Aug. 15. This marks the highest increase since the fourth quarter of 2022.

Excluding the drag on earnings from the energy sector, the Russell 2000’s year-over-year earnings growth stands at 28.3%.

The real estate sector led the charge with a 54.9% year-over-year earnings growth, followed by the health care sector, which saw a 47.2% increase.

Overall, about 60% of small-cap companies that reported their latest quarterly results beat analysts’ earnings expectations. On the revenue side, 55.9% of these companies surpassed analyst forecasts.

Looking ahead, analysts are optimistic about small caps. For the third quarter of 2024, Russell 2000 earnings are expected to grow by 43% year-over-year, while for the fourth quarter, the growth rate is projected to soar to 73.8% year-over-year.

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