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Will Ashworth

Small-Cap Stocks Look Ready to Take Off in 2024

In my final commentary about unusual options activity before Christmas, I thought I’d give all Santa-loving options investors an easy layup. 

Judging by yesterday’s UOA for the iShares Russell 2000 ETF (IWM), I don’t think there’s any question that the bullish bet for 2024 is small-cap stocks. However, although IWM is up more than 15% year-to-date, that pales compared to the 24% return for the S&P 500. 

On three occasions in 2023, IWM has tried but failed to blow through the $200 level, retreating badly on two of those occasions in the spring and early fall. Now, nearly $2 over $200, the third time will be a charm. 

In 2024, I see IWM testing its all-time high of $244.46 in November 2021. 

Here’s why I feel this way, along with a few options to benefit from a small-cap resurgence in the year ahead. 

Happy Holidays!

Small Caps Are So Due!

A Wealth of Common Sense blogger, Ben Carlson, updates his favorite performance chart every year in the first week of January. The chart is an asset-based play on the scientific periodic table. Ben’s table has 11 asset classes, including small caps. 

The last time small-cap stocks led all 11 for annual performance was in 2016. Before that, 2013. Since small caps’ 2016 win, large caps have won the title thrice, with another win expected in 2023. Large caps were the first or second-best performing asset class in five out of the last 10 years between 2013 and 2022.

Reversion to the mean is ready to set in. 

But I’m not just willy-nilly throwing this small-cap resurgence out there in 2023. There are plenty of smart people on Wall Street pushing the same message. 

For example, Fortune reported on Dec. 15 that Fundstrat Global Advisors cofounder Tom Lee felt small-cap stocks would jump by 50% in 2024. Lee also predicted that the S&P 500 would gain 25% in 2023. He’s right on the button. 

Why is Lee so optimistic? It has to do with two things: inflation and interest rates. He believes inflation will hit the Federal Reserve’s 2% target in 2024. That will lead to interest rate cuts, which is music to the ears of CEOs running smaller companies. 

“On a price-to-book basis, [small-caps] are trading at where they were in 1999, relative to the S&P. And that was the start of a 12-year outperformance cycle,” Fortune reported Lee’s comments. 

On Dec. 21, Barron’s published Small-Cap Stocks Are Taking Off. Forget Big Tech. The article provided positive comments from Royce Investment Partners co-chief investment officer Francis Gannon.

“Small-caps are [still] cheap from a valuation perspective. They have priced in a recession that has yet to materialize,” Barron’s cited Gannon’s comments about small caps. “You are at the cusp of what is going to be a regime change in the market, and small-caps are going to be part of it.”

I couldn’t agree more. Small caps look priced to move unless there’s a significant turn of economic events in 2024.    

Small Caps Could Have Thrown in the Towel

At the end of October, IWM hit a 52-week low of $161.67, its lowest level in three years. Instead of continuing to push lower, it followed its large-cap brethren in the November rally. From its Oct. 27 low, its share price is up 24%. 

As I write this early in Friday trading, IWM has broken through $200 and sits about $2 above this critical level. Whether it holds or not is the big question. 

Someone like Lee, who’s been in the business a while -- he used to be the chief equity strategist at JPMorgan until starting Fundstrat in 2014 -- wouldn’t be throwing out a 50% potential gain in 2024 on top of the 24% gain in the final two months of 2023, if he didn’t feel strongly about the direction of inflation and interest rates. 

North of the border, Canadian Larry Berman, head of ETF Capital Management and a weekly guest on BNN Bloomberg TV, had interesting things to say about small caps in his Nov. 27 commentary about where the markets might go in 2024. 

“Keep U.S. small caps on your radar for the next few years. They are close to multi-decade lows on valuations. They are on my radar. In the US (IJR), for Canadians on the TSX (ZSML, XSU, MUSC) are all good ways to play it depending on your currency views and liquidity needs,” Berman wrote. 

“If the economy is going to hit a soft landing, then small caps should outperform. This year was and still is a chase performance year as average stock performed poorly, with 32 per cent of NASDAQ stocks above their 200-day average and just 48 per cent of the NYSE.”

The ETF Play Using Options

Berman mentions the iShares Core S&P  Small-Cap ETF (IJR). He likes it better than IWM because it tracks the performance of the S&P SmallCap 600 Index, a better group of smaller companies in his estimation than the Russell 2000. 

So, I’ve selected one unusually active option from yesterday’s trading for both ETFs. Please remember that I always choose from contracts that expire in 7 days or longer. 

First up, IWM. It had 31 unusually active options on Thursday. I’ll look to gain as many days to expiration as possible while making a sensible bet proposition. 

The April 19/2024 $250 call stands out. It had a volume of 3,765 yesterday, 5.77x its open interest. The ask price was a low $0.42 with a 0.04375 delta. You’re looking at a down payment of just 0.16%. Of course, there’s a reason for that: it’s unlikely to increase by 25% over the next 119 days. 

However, it only has to rise by 5% over the next four months for you to double your money by selling the option before expiry. 

As for IJR, it’s a straightforward process, as there was only one UOA yesterday. That would be the Jan. 17/2025 $108 call with an ask price of $12.20 and a 0.59965 delta. 

The ask is an 11% down payment on IJR stock. With more than a year to expiration, the high DP makes sense. To consider exercising your right to buy 100 shares in January 2025, its share price must rise to $120.20, or 12% over the next 392 days. 

I think that’s doable. However, you won’t be able to sell your call early and double your money like the IWM call from earlier. That’s because, with a delta of 0.59965, its share price must increase by 20% over the next 13 months. 

However, if it does that, you might be inclined to hang on to the shares in 2025 to benefit from additional appreciation. 

I’d go with the lower initial bet of $42 with IWM rather than $1,220 with IJR if it were me.

 

On the date of publication, Will Ashworth did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
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