Bearish Bets on Small-Cap Stocks Ease on Earnings Outlooks

(Bloomberg) -- The worst could be over for small-cap companies rebounding after entering a bear market last week.

Between Wall Street targets projecting double-digit gains by the end of the year and easing bearish wagers, an investment case can be made for those riskier stocks acutely tied to economic growth. The Russell 2000 index is jumping for a second day after its recent drawdown hit 20% from an all-time high. The recent rally trimmed its January rout to a little over 10%. The gauge has seen only seven up sessions -- including Monday's -- since the start of 2022.

For Jefferies' Steven DeSanctis, one reason to be bullish is the fact that the outlook for earnings growth hasn't suffered so much. He's sticking to his 2,350 target for the Russell 2000 this year, which implies a 17% surge from Monday's levels. The strategist also says that the purge of exchange-traded funds tracking small caps could be coming to a close soon. Meantime, short interest on those shares -- which are generally viewed as a higher-risk alternative relative to bigger companies -- has stabilized after rising earlier in 2022, according to Chris Harvey at Wells Fargo Securities.

Megan Horneman, chief investment officer at Verdence Capital Advisors, said she sees opportunities in the small-cap space, and her firm has been actively adding to their small-cap positions recently.

“They've been a laggard for several months now, so I think if you're looking at a little bit of a longer-term time horizon, and you can withstand some of the volatility, there is some opportunity in the small-cap and mid-cap space as well,” she said.

Risk assets sold off in January amid growing conviction the Federal Reserve will soon raise rates as it ratchets back its ultra-accommodative policy to combat the fastest inflation in nearly 40 years. During that span, smaller companies have underperformed their bigger peers on concern about their ability to absorb higher input prices, among other factors.