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RUSSELL 2000 RALLY SET TO FADE AS VALUATIONS RISE, GROWTH NORMALIZES, GOLDMAN SAYS

Goldman Sachs' strategists expect the small-cap Russell 2000 .RUT index's sharp first-half rally to give way to more modest gains over the next 12 months, they said in a note, as valuations become less attractive and economic growth moderates.

The index — commonly used as the main benchmark for U.S. small-cap stocks — has gained 21.4% so far this year, outstripping the S&P 500's .SPX 9.3% rise.

The rally, however, is not here to stay.

"The combination of elevated valuations and near-trend US economic growth points to low single-digit Russell 2000 returns in the next 12 months," Goldman strategists led by Ben Snider said in a note dated July 1.

A key driver of the index's strength, the AI trade, is likely to diminish, strategists said. The recent index reconstitution reduced the weight of AI infrastructure stocks in the Russell 2000 to 7% from 15%, removing some of the largest contributors to the index's first-half gain.

The index trades at a price-to-book ratio of 2.4 times, below the 2.6 times level before the recent rebalance but above both its long-term average of 2.1 times and the 2.2 times multiple at the start of the year, they said.

Goldman also said revisions to the AI capital-expenditure outlook may be less of a catalyst in the coming earnings season than in the prior quarter.

Outside of AI, the combination of an accelerating economy and an easing Fed at the start of 2026 created an ideal backdrop for small-caps. Those macroeconomic tailwinds appear to be less favorable in H2, Snider said.

While Goldman expects the U.S. central bank to remain on hold throughout 2026, markets are increasingly pricing in interest-rate hikes before the end of the year.

Small-cap stocks tend to be more sensitive to interest-rate expectations, making them vulnerable to shifts in inflation risks.

"Nonetheless, small-caps should continue to generate positive returns during the remainder of 2026, and the opportunity set for stock-pickers should remain very attractive," Goldman Sachs said.

(Kanchana Chakravarty)

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