Amidst a rally in recent days, the Russell 2000, a widely monitored index of small-cap stocks, has reignited hopes that this section of the equity market is on the cusp of recovery after a prolonged period of underperformance. However, this scenario of anticipation has played out multiple times in recent history, prompting the question – is this time truly different?

The latest surge in the Russell 2000 has sparked fervent headlines claiming a turning point. One source heralds a “Major Technical Breakout.” Another boldly predicts a forthcoming rally in 2025, while CNBC reports the encouraging narrative that “Small-cap stocks are showing signs of life.”

For seasoned observers, this might sound like a familiar tune. Back in March, we read headlines like “Hope Springs Eternal, Again, For Small-Cap Equities,” yet small caps have failed to live up to the expectations and continued to lag behind the broader equity market.

Despite the recent resurgence in optimism, small caps still carry the burden of proving their strength relative to their peers. Year-to-date comparisons reflect poorly on small-cap stocks. The iShares Core S&P Small-Cap ETF (NYSE: IJR) continues to significantly trail the broad US stock market (SPY), with a performance gap of 10.9% for IJR versus 23.7% for SPY.

While small caps (IJR) have somewhat closed the gap in the past month, with both IJR and SPY posting nearly 4% gains, the performance dynamics are far from convincing.

The recent technical profile of IJR appears robust, hinting at a potential sustained uptrend that might prolong the positive momentum.

Given these developments, the contrarian case for betting on small caps is gaining traction. A comparative analysis of IJR against a diverse range of factor ETFs for year-to-date returns highlights the underperformance of small caps across various equity segments. This underperformance could potentially pave the way for a normalization trend in favor of smaller companies.

A quote from Adam Turnquist, chief technical strategist at LPL Financial, emphasizes the impact of economic conditions and interest rates on small caps, underlining their sensitivity to these factors. The implication being that the expected continued easing of interest rates by the Federal Reserve against the backdrop of a buoyant US economy could fuel an extended rally in small-cap stocks.

Hope seems to be rekindling for these stocks once again, and for portfolios looking to rebalance their exposure to small caps, the current landscape may present an opportune moment to take a calculated risk and align with the optimists.