Since the start of August, the small cap Russell 2000 is up 4.2%. That compares to a gain of just 1.5% in the S & P 500. "Small has a very good chance of continuing to outperform large in the near-term," said Steven DeSanctis, Jefferies equity strategist.

The Russell 2000 has traded inside a well-defined downward sloping trading range since making a high in November. Small caps have led the market out of nine of the last 10 recessions. While investors may expect interest rate hikes to hurt the small universe, MKM's chief technician JC O'Hara said that's not the case.

Small caps bottomed three months after the Federal Reserve raised its fed funds rate in March. O'Hara recommends overweighting small cap technology and industrials. DeSanctis said he sees Jefferies' proprietary valuation model pointing to a period of outperformance for smaller stocks.

Over the next 12 months, small caps should beat large caps by 6%, DeSanctis says. M & A resurgence is also helping small caps. Pfizer announced it was buying Global Blood Therapeutics for $5.4 billion. Last week, Ping Identity agreed to be bought by Thoma Bravo for $2.8 billion.

Small caps can be winners when there are market turns, DeSanctis says. "We don't think there's a recession until the back half of 2023. So we've got some time here," he says. For investors who want to play small caps through ETFs, there is a difference between Russell 2000 and S & P 600.
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