Wall Street's popular 2024 trade has been suspended amid uncertainty over when the Federal Reserve will cut interest rates.
Many equity strategists had been expecting a turnaround in small-cap stocks since the beginning of the year, as there was a consensus that the Federal Reserve would start cutting interest rates in the first half of 2024. Now, with the market dialing back expectations for interest rate cuts this year, we're hoping for a turnaround in small-cap stocks. The Cap Russell 2000 Index (^RUT) is down nearly 3% since the beginning of the year, lagging the S&P 500 Index's more than 5% gain this year.
“We think the Russell 2000 could be a bit of a challenge in the near term until we get certainty that inflation is slowing and the Fed can start cutting rates,'' Bank of America's head said. ” he said. Jill Carey Hall talks to Yahoo Finance about her U.S. mid- and small-cap strategy.
After a recent conversation with investors, Hall said the main catalyst for small-cap stocks rallying is more clarity on the Federal Reserve's interest rate path. The reasons for this are largely unchanged from why investors favored small-cap stocks at the beginning of the year.
But investors are given little assurance that a rate cut will happen anytime soon. The market consensus has changed from early January's expectation of seven rate cuts this year to two this year, according to Bloomberg data. This move will significantly put a damper on small-cap stocks heading into late 2023, while large-cap stocks continue to rise this year.
Recent research from Morgan Stanley Chief Investment Officer Mike Wilson shows that small- and large-cap stocks are much more sensitive to interest rates following the recent rise in U.S. Treasury yields.
“Small cap and low quality areas of the market [have] “We are underperforming due to our sensitivity to rising interest rates and our highly leveraged balance sheet,” Wilson said on April 15. “We maintain a stock quality bias.”
The main difference is the debt structure of the companies. The small cap carries more than 40% of its debt in the form of variable rate loans, short-term debt that is exposed to current interest rates or that may need to be refinanced in a higher interest rate environment. That compares with about 75% of S&P 500 companies with long-term fixed debt, according to Bank of America's research team.
Additionally, large companies often hold more cash that could benefit from rising interest rates, and keeping the Fed rate fixed is simply more costly for small businesses than for large businesses. Please add that.
” [Russell 2000] “The index is very sensitive to credit and interest rates,” Hall said, adding, “Given that large-cap stocks have been able to lock in a lot of long-term fixed-rate debt, refinancing risk is an important risk for these companies.” said. … The longer interest rates remain high, the greater the risk to these companies' earnings. [smaller-cap] companies. ”
Hall said signs that the economy continues to grow faster than expected this year has sustained some of the small-cap bull market, with profits expected to rebound later this year.
Greg Tuorto, a portfolio manager at Goldman Sachs Asset Management, still believes there is opportunity in small-cap stocks and agreed with Hall.
“The underlying strength of the economy is always what drives small-cap stocks,” Tuorto told Yahoo Finance. “This is a very domestic asset class. It's very much driven by what's going on in the U.S. economy. So you shouldn't discount the strength of the U.S. economy in small-cap stocks.”
But Tuorto said changing expectations for Fed interest rate cuts remained a headwind for the group and was a larger driver of recent market moves.
Josh Schafer is a reporter for Yahoo Finance. Follow him on X @_joshschafer.
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