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Wall Street was off to a volatile start in 2025, following a steep sell-off in the final weeks of 2024. Notably, the small-cap Russell 2000 Index fell 8.4% in December, marking its worst month since September 2022. The index is up 0.4% in the initial week of 2025. Smooth trading is likely to continue given the “January Effect," which refers to a seasonal increase in stock prices during the month.
For investors looking to capitalize on this opportunity, small-cap stocks that are down in double-digits or in high single digits over the past month and have a solid Zacks Rank #1 (Strong Buy) or #2 (Buy) and a Momentum Score of B or more seem solid choices. These include Boundless Bio Inc. BOLD, HomeStreet Inc. HMST, Synchronoss Technologies SNCR, Pitney Bowes PBI and USANA Health Sciences Inc. USNA. You can see the complete list of today’s Zacks #1 Rank stocks here.
January Effect Seems Real This Year
Small-cap stocks tend to outperform large-caps during the month. According to some market experts, the January Effect actually runs from mid-December through February.
This is driven by tax-loss harvesting, where investors sell losing positions in December for tax purposes and reinvest in January. Additionally, year-end bonuses and portfolio rebalancing drive the stock market higher in the first month of the year. Further, the start of a new year often brings renewed optimism among investors, leading to increased buying activity.
On the macro front, the economy is on a solid footing, household net worth is at an all-time high and the labor market is healthy. The latest bouts of data indicate a strong economy. As small-cap companies are more domestically tied, they are poised to outperform when the economy improves. President-elect Trump's policies of deregulation, lower corporate tax rates, restriction on illegal immigration and enactment of new tariffs would further provide more stimulus to the U.S. economy and benefit small-caps the most. This shift will allow small-cap businesses to operate with increased profitability.
As small-cap companies often lack the financial resources of larger firms to manage regulatory compliance, reduced regulations mean lower operational costs. Trump’s proposed tariffs against major U.S. trading partners would boost the greenback. A strong dollar provides an edge to domestic-focused companies as small caps do not have much exposure to the international market. Trump's protectionist stance will benefit domestic producers, as higher import tariffs raise costs for foreign competitors.
Moreover, pint-sized companies have a higher debt burden (mostly at floating rates) and thus lower rates lead to reduced borrowing costs, helping small businesses expand their operations easily and resulting in increased profitability. The Fed has slashed interest rates by 100 bps since September. The escalation in geopolitical tension will also provide a boost to domestically-focused stocks.