Wall Street is optimistic about the continuation of the small-cap stock market, but warns to beware of the "high volatility trap."

Small-cap stocks in the United States are currently experiencing a moment in the spotlight, and Wall Street generally expects that this trend will not end quickly. The Russell 2000 index, considered to be the epicenter of the riskiest stocks in the market, has just set a record for the longest streak of outperforming large-cap stocks since 1996. Although this performance is impressive, historically, market trends that reach such leading levels are often hard to sustain. However, strategists say there is no need to worry. As the bull market led by large-cap tech stocks begins to spread, they are optimistic about the outlook for small-cap stocks. This assessment is mainly based on expectations that lower interest rates and economic growth will accelerate profits for small-cap stocks. In addition, regulatory easing, narrowing credit spreads, and further rate cuts will provide tailwinds for these high-beta stocks. Sebastian Page, Chief Investment Officer at T Rowe Price, which manages nearly $1.8 trillion in assets, says, "Moderate economic growth coupled with falling or lower rates can push small-cap stocks higher. We believe this trend may continue for another six months." He also acknowledges the risks of being long on small-cap stocks: the sector outperformed the S&P 500 index in the first 14 trading days of the year, but this momentum was interrupted last Friday and has since continued to lag behind the S&P 500 index. "This was once a value trap. It looked cheap, attractive, may perform well in a few weeks, but ultimately it's still a trap," Page added. Despite this, Page remains overall overweight on small-cap stocks, anticipating that the sector will benefit from sustained economic growth and expectations of lower rates. Many investors and strategists who share a similar view expect the current weakness to be temporary, and small-cap stocks will once again significantly outperform large-cap stocks. Jonathan Krinsky, Chief Market Technician at BTIG LLC, said in a report on Monday, "We may see more pullbacks, but subsequently, we expect small-cap stocks to regain their leadership position." Dan DeBusschere, President and Chief Market Strategist at 22V Research, also believes, "Small-cap stocks have a dual tailwind of macro and fundamentals. If artificial intelligence is proven to enhance productivity, this will particularly benefit companies with lower earnings bases, such as mid-cap stocks." He recommends investors to go long on regional banks, transportation stocks other than airlines, and non-essential consumer goods sectors. Investors are also betting that fiscal stimulus measures, including tax cuts passed last year, will boost the sector in the 2026 fiscal year, as they are highly sensitive to the US economy. "They are the purest US equity assets you can own," said Peter Roy, Small Cap Portfolio Manager at Argent Capital, noting that compared to large-cap stocks, small-cap companies derive more of their revenue from the US, benefiting from the "accelerating and potentially broadening US economy." However, risks exist when large funds rotate into small-cap areas, as individual stock prices may experience more volatile fluctuations due to their relatively lower liquidity. This means that long-term investors may need to tolerate higher volatility. Michael Dickson, Head of Research and Quantitative Strategies at Horizon Investments LLC, suggests traders to plan ahead: "This relative volatility will become more normal than exceptional." It is worth noting that giants like Apple Inc. (AAPL.US), Alphabet Inc. Class C parent company Alphabet (GOOGL.US), and NVIDIA Corporation (NVDA.US) each have market values that exceed that of the entire Russell 2000 index (which has a total market value of about $3.6 trillion). Recently, Goldman Sachs Group, Inc. has warned that when investors rotate from large-cap stocks and partially move into small-cap stocks, liquidity may pose a barrier. However, many investors still see small-cap stocks as a corner of the market that is currently undervalued, long neglected, yet enjoying multiple tailwinds. Dickson concludes, "This is an area of the market with low holdings. Lower valuations bring risks, but it is currently an attractive entry point."