A famous aphorism holds that a “rising tide lifts all boats,” but small-cap stocks are still waiting for a boost from the 2024 Wall Street bull market.
While the S&P 500, which is made up of larger companies, has rallied more than 17 percent so far this year, the small-cap Russell 2000 is up 0.4 percent.
Market watchers point to high U.S. interest rates — at a 22-year high — as a factor behind the yawning wealth gap, since smaller companies typically borrow more than larger companies because they are less profitable.
Smaller stocks “tend to get hurt more by higher interest rates,” said Sam Burns, chief strategist at Mill Street Research.
“I think it causes a lot of variance in earnings, which then shows up in relative returns.”
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But that momentum also means small-cap stocks could be poised to prosper if the Federal Reserve pulls the trigger and cuts interest rates soon.
A Fed rate cut in September could be the “first catalyst” for small-cap funds to take off, said Art Hogan of B. Riley Wealth Management.
If that happens, “small caps might catch a bid in anticipation of the Fed cutting for the first time because it tends to start a pattern of more cuts and lower rates,” Hogan said.
Futures markets are currently predicting two rate cuts in 2024, one in September and the other in December.
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However, not all market watchers attribute small-cap underperformance to high interest rates.
“It’s more about what the economy is doing,” said Kim Forrest, chief investment officer at Bokeh Capital Partners, who described conditions as “soft.”
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“It’s not even linked to interest rates, because companies are certainly not going to borrow to expand,” he said.
Sam Stovall of CFRA Research sees high interest rates as a reason for the initial underperformance of small-cap stocks.
But stocks “didn’t tend to soar immediately after because of concern about an economic slowdown,” he said.
Burns notes that a disproportionate share of the market’s progress in 2024 is enjoyed by large technology companies that lead the AI ββmanufacturing industry, adding that larger companies are best positioned to monetize the advances.
Technology “is a much bigger proportion of the S&P 500 than it is for, say, the Russell 2000,” Burns said. “And even in tech, I think large caps still do better than smaller-cap tech companies on average.”
Forrest agrees, saying of the “unfavorite” stocks in her portfolio that “basically, there’s nothing wrong with them, except they’re not Nvidia.”
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Market participants also note the growing influence of exchange-traded funds, or ETFs, which account for about $8 trillion held in U.S. markets.
These investment vehicles are largely comprised of large-cap companies.
Market watchers also see a bias in sentiment toward larger companies, even outside of tech.
“The big banks have gotten bigger,” notes Burns, who sees many industries where the smaller players “are struggling or just can’t keep up.”
Source: AFP