5 Catalysts Set to Spark a Small-Cap Rally Before Year-End
On October 31, 1991, three powerful weather systems collided over the North Atlantic Ocean.
A hurricane, a cold front and a nor’easter.
Waves reached heights of 100 feet. Winds roared past 80 knots. Meteorologists later said a convergence like this only happens once every 50 to 100 years.
Caught in the middle was the Andrea Gail, a commercial fishing boat that had set sail from Gloucester, Massachusetts, weeks earlier. Tragically, the vessel and its six crew members were lost at sea.
The disaster inspired the bestselling book and blockbuster movie The Perfect Storm, which helped popularize the expression we still use today to describe several powerful forces converging at once.
Of course, the stakes are very different when we’re talking about the stock market. But I believe a convergence of forces is developing that could create a remarkable opportunity for investors.
Specifically, I see five separate catalysts coming together between now and year-end that could help propel fundamentally superior small-cap stocks higher.
In today’s Market 360, I’ll walk you through those five catalysts, explain why smaller companies could be among the biggest beneficiaries. I’ll also show you how my Precursor Intelligence system can help identify potential winners before the rest of Wall Street catches on.
Catalyst #1: Third-Quarter Earnings Season Is Just Getting Started
The earnings party is just getting started. This is the catalyst I’m watching most closely.
According to FactSet, Wall Street now expects S&P 500 earnings to grow 29% from a year ago, compared with the 26.7% growth expected when the quarter began. That 29% figure combines results already reported with estimates for companies still to come. And since we know that companies have a habit of positive earnings surprises, it could be even higher. Either way, this would be the third straight quarter of earnings growth above 25%.
What’s especially encouraging is that analysts raised their earnings estimates during the quarter. That’s unusual, as analysts typically lower estimates as the quarter progresses. But this is the second quarter in a row that they’ve raised them.
Companies have also been more upbeat than usual. Among those issuing third-quarter earnings guidance, 62% provided outlooks above analysts’ expectations, compared with a five-year average of 40%.
And while the size of early earnings surprises has been smaller than usual, 84% of companies that have reported so far have beaten earnings estimates.
But here’s what really catches my attention.
Royce Investment Partners found that analysts expect earnings growth for small-cap companies to exceed that of larger companies in both 2026 and 2027.
That’s an encouraging sign that the next wave of earnings growth could extend beyond the big-name stocks that have dominated the headlines.
A smaller company that increases sales while keeping its costs under control can grow profits much faster than revenue. Factory overhead and other fixed expenses do not have to rise with every additional order. More of the next sales dollar can reach the bottom line.
Of course, a big percentage increase can also reflect a rebound from weak profits. That’s why I still want to see strong sales, expanding operating margins and healthy cash flow supporting the earnings growth. Management’s outlook for the next quarter matters, too.
So, as third-quarter earnings season gathers speed, I expect companies with the strongest fundamentals and most encouraging guidance to stand out.
Catalyst #2: A Likely Pause in Interest Rates
The Federal Reserve may give small caps some breathing room at its October meeting.
September’s employment report showed just 29,000 new jobs, and the unemployment rate stood at 4.2%. July and August payrolls were also revised down by a combined 60,000.
Those numbers suggest the Fed has good reason to pause and assess the impact of September’s rate hike.
Meanwhile, the inflation picture is mixed.
The Consumer Price Index (CPI) rose 0.6% in September and 3.7% over the past year.
The Producer Price Index (PPI) was even hotter, jumping 1.3% for the month and 6.3% over the past year.
The culprit: Skyrocketing energy prices.
So, the Fed still has some work to do. But with the labor market cooling, policymakers may be reluctant to raise rates again so soon.
The market seems to agree with my opinion, too. The Fed announces its next decision on October 28. The consensus is that an October rate hike is off the table.
That’s particularly important for small caps.
Smaller companies tend to be more sensitive to changes in interest rates. That’s because they often rely more heavily on floating-rate loans and outside financing than larger companies do.
Consider a company with $100 million in floating-rate debt. If its borrowing rate rises another quarter of a percentage point, that adds $250,000 to the annual interest bill.
That’s why I look for small companies with manageable debt and enough sales and profit growth to carry their financing costs. Continued growth alongside a more patient Fed would give those businesses a better chance to deliver.
Catalyst #3: Greater Clarity After the Midterms
The November 3 midterm elections will remove another obstacle for the market – uncertainty about the direction of Washington.
As the results become clear, businesses and investors should have a better idea of what to expect on taxes, regulation and federal spending. That can make it easier to evaluate an investment or move forward with an expansion.
There is a favorable historical pattern here – especially for smaller companies.
The Russell 2000 has gained an average of 6.2% over the 60 trading sessions following midterm elections since 1982. Small caps posted positive returns during that stretch in eight of the 11 periods studied.
Now, an election does not, by itself, eliminate a company’s financing costs or create demand for its products. You still need the economic and earnings backdrop to be there.
But on that front, there is encouraging news.
The government’s latest estimate showed that inflation-adjusted consumer spending and private fixed investment grew at a 4.6% annualized pace in the second quarter. That measure captures spending within the private U.S. economy, including investment in equipment, buildings and housing.
That matters to smaller businesses supplying equipment, serving local customers and building new construction projects.
My view is that greater clarity in Washington could help investors refocus on companies already turning that domestic demand into higher profits.
But here’s the important thing to remember.
If Democrats get control of the House or the Senate or even both, President Trump has already frontloaded his economic agenda.
Either way, we will likely have a divided government. History shows that’s generally good for stocks.
Catalyst #4: A Second Russell Reconstitution
Small-cap investors have another date to watch this year: December 11.
That’s when FTSE Russell’s first December reconstitution in more than 30 years takes effect after the market closes.
For decades, the Russell indexes have undergone a major reshuffling just once a year, in June. Starting in 2026, that process will happen twice a year.
Here’s why it matters.
Russell ranks publicly traded companies by market capitalization. The largest 1,000 go into the Russell 1000, while the next 2,000 make up the Russell 2000 small-cap index.
When a company enters one of these indexes, the funds that track it must adjust their holdings. That can create significant buying pressure in newly added stocks.
And when billions of dollars move at the same time, the market notices.
The reconstitution is also one of the few times each year when investors get a clear look at which companies are moving up in the ranks – and which are falling behind.
This year, those rankings matter more than usual.
This comes at a particularly interesting time because it could coincide with both stronger earnings growth and seasonal buying in small-cap stocks.
I’ve seen firsthand how powerful these shifts can be.
Take Power Solutions International, Inc. (PSIX) for example. I recommended it to my Accelerated Profits subscribers in January last year.
Power Solutions makes engines and power systems used in heavy equipment, commercial vehicles and backup power applications – and increasingly, in data centers.
At the time, it showed a history of posting big earnings surprises and increased analyst estimates. So, I had to make sure my subscribers could get in.
Five months later, it was added to the Russell 3000 during last year’s reconstitution. Once it became official, PSIX climbed 21% in the first week.
That’s a big move. All told, we ended up making 121% gain on PSIX by the time we sold it in May this year.
Now, index inclusion alone doesn’t guarantee a stock will surge. But when growing institutional demand meets strong sales and earnings, the results can be impressive.
And with another Russell reconstitution just weeks away, I’ll be watching closely for companies showing those same characteristics.
Catalyst #5: Seasonal Strength and an “Early January Effect”
The seasonal calendar is also about to become more favorable.
November begins the stock market’s historically stronger November-through-April stretch. Small caps have an additional pattern around the turn of the year: the tendency to outperform larger stocks known as the January effect.
Despite its name, that pattern can start before January.
In fact, December has historically been one of the most favorable months for smaller stocks.
There are a few reasons for this. But one of the most powerful is simply window dressing – where managers sell duds and buy stocks with good fundamentals to make their portfolios look “pretty.”
How I Find Tomorrow’s Market Leaders
With these five catalysts converging, the question is which small-cap stocks are best positioned to benefit.
That’s where my Precursor Intelligence (P.I.) system comes in.
P.I. analyzes roughly 6,000 stocks and ranks them based on eight fundamental signals and one quantitative money-flow signal.
Without a system like this, a stock like Power Solutions might not even be on the radar for most investors until after the buying pressure has already shown up.
That is why I recently put together a special presentation that shows you what my P.I. system is flagging right now. I explain how it works, why institutional buying matters and how you can use these signals to spot promising stocks before the rest of Wall Street catches on.
You can get the details and learn what P.I. is flagging today by clicking here.
Sincerely,
Louis Navellier
Editor, Market 360
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