A top Wall Street strategist breaks down why small-cap stocks could gain 12.5% next year in one of his most bullish forecasts since 2003

• Jefferies' Steven DeSanctis said the Russell 2000 small-cap index could gain 12.5% next year to reach 2050. It's one of the most bullish forecasts he's made since 2003.
• The strategist explained that recovering GDP, increased M&A activity, strong earnings, and a weaker dollar will all aid small-cap performance next year.

• Small-cap stocks could even outperform large-cap stocks in 2021, DeSanctis said.

• His forecast comes after the Russell 2000 posted its highest-performing month ever. The small-cap index gained 18.29% in November.

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Small-cap stocks are set to make a big comeback in 2021, according to Jefferies' Steven DeSanctis. The small and mid-cap strategist forecasts that the Russell 2000 will rise 12.5% to 2050 next year. It's one of the most bullish calls his team has made since 2003.

If they're correct, next year would be the first time since 2016 that small-caps beat large-caps. DeSanctis estimates that small will beat large by 6.4%.

In a Tuesday note to clients, DeSanctis laid out a number of reasons why 2021 has a positive backdrop for small stocks. The Jefferies US GDP forecast is at 4%, and with GDP at that level, small stocks have gained nearly 17%, said DeSanctis. He also said M&A activity will pick up next year, and the dollar will weaken, and this will aid small-caps. Jefferies expects small-caps earnings to grow 40% in 2021.

The strategist added that small-caps recovered impressively off their lows from the pandemic-induced crash in the spring. The Russell 2000 has gained over 80% since its lowest point in March.

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DeSanctis also noted that small-cap stocks just had their best month of all time in November as vaccine progress pushed investors into beaten-down segments of the market. The Russell 2000 gained 18.29% in November, its highest performing month since its inception in 1984.

Because of this November rally, DeSanctis said there may be a pullback between 5% and 10% in the near-term before momentum picks back up in 2021.

"It was a November to remember with Russell putting in its best showing EVER. This comes after one of the biggest/fastest draw downs ever. When small has bounced as much as it has, the good times keep rolling," he said. "We would like to see 'The pause that refreshes' with a pullback of 5% to 10%."

The strategist added he's watching the IPO calendar, as it's over-heated and that could be a risk for small-cap performance going forward.

DeSanctis has an overweight rating for industrials, materials, health care, and real estate.