Investors are turning to this neglected part of the stock market. And it's still cheap.

Investors are increasingly turning to small-cap stocks as the broader S&P 500 market exhibits stretched valuations. Over the past month, small-cap indices have significantly outperformed, with the Russell 2000 and S&P Small Cap 600 returning 7.7% and 7.5% respectively, compared to the S&P 500's 2.7% gain, signaling a potential shift in capital towards this previously neglected and still relatively inexpensive market segment.

Analysis

A significant performance divergence has emerged between U.S. large-cap and small-cap equities, signaling a potential shift in investor focus and capital flows. Over the past month, the small-cap segment has demonstrated notable strength, with the Russell 2000 Index (RUT) and the S&P Small Cap 600 Index (SML) delivering total returns of 7.7% and 7.5%, respectively. This performance starkly contrasts with the S&P 500's (SPX) modest 2.7% gain over the same period, a divergence reflected in the positive sentiment (0.6) for small-cap ETFs versus the slightly negative sentiment (-0.2) for the SPY. The primary catalyst appears to be valuation concerns, with the S&P 500 perceived to have reached a 'stretched valuation' relative to earnings. The characterization of small-caps as 'neglected' and 'still cheap' suggests that this recent outperformance could represent the beginning of a broader catch-up trade as investors seek more attractively priced assets.

Key Decisions for Investors

• Investors with heavy large-cap exposure should review portfolio allocations, as the S&P 500's stretched valuation presents a risk, while the relative cheapness of small-caps offers a compelling alternative.
• The strong recent momentum, with small-cap indices nearly tripling the return of the S&P 500 over the past month, presents a tactical opportunity for investors to gain exposure to a potentially nascent rally.
• Consider initiating or adding to positions in small-cap focused instruments, such as ETFs tracking the Russell 2000 (IWM) or S&P Small Cap 600 (SPSM), to capitalize on this apparent market rotation.