The Russell 2000 should beat the S&P 500, if it can overcome these 3 headwinds, Goldman Sachs says
- The Russell 2000 should rise by 14% in the next 12 months, Goldman Sachs wrote.
- Meanwhile, the S&P 500 is expected to climb 9% in that span, analysts said in a note.
The Russell 2000 can swing past the S&P 500 over the coming year, but it all depends on its ability to weather certain headwinds, a Goldman Sachs report said on Wednesday.
According to model based on US economic growth and starting valuations, the small-cap index should gain 14% in the next 12 months. Meanwhile, the S&P 500 is expected to climb 9% in that span.
That would mark a rare role reversal as the S&P 500 typically outperforms the Russell 2000. However, the small-cap index's potentially bigger returns also carry more risk, the note said.
Goldman outlined three near-term macro headwinds the Russell 2000 faces:
1. Rising interest rates
The index is more vulnerable to monetary tightening as listed companies tend to be more burdened by debt when compared to those of the S&P 500. As interest rates keep rising, debt servicing costs may gradually add pressure on small caps, as nearly one-third of the Russell 2000's debt is floating rate.
This may become a complication through the rest of the year, as the Federal Reserve has indicated the possibility of two more hikes. For its part, Goldman anticipates one more hike in July, and forecasts cuts for 2024.
2. Economic growth
Compared to the S&P 500, the Russell 2000 is more exposed to US economic performance, Goldman wrote. Even if a recession was avoided, small-cap equities tend to struggle to outperform in the later stages of a business cycle, as investors turn towards companies with bigger balance sheets.
In addition, markets appear to have already priced in GDP forecasts, and any further upside to growth looks unlikely while the Fed continues to bring inflation down, Goldman noted.
3. Sector composition
The Russell 2000's greater exposure to cyclical stocks, regional banks, real estate, and biotech makes it more vulnerable to slowing growth, rising rates, and any re-emergence of financial stability fears, Goldman said.
That means more cuts to earnings forecasts may be on the way. While earnings revisions among S&P 500 companies have mostly flattened out, Russell 2000 revisions are continuing, the note said.