After a mostly dull beginning to the year, U.S. small-cap stocks look like they’re about to take off in the second half of 2024.
This week, a lot of investors sold big-cap tech stocks and put their money into rougher parts of the market. This was done because new data showing that inflation is going down made people bet that the Federal Reserve will start cutting interest rates this fall.
Market strategists told BourseWatch that the fact that small-cap stocks have done better than the overall market is likely just a natural shift into the sector that isn’t doing as well as investors look for deals after the S&P 500 SPX hit all-time highs, not a bet on more rate cuts this year or a strong U.S. economy.
This week, the Russell 2000 index RUT, which tracks the performance of 2,000 small and medium-sized companies that are part of the Russell 3000 index RUA, rose 6%, beating the S&P 500 by the largest margin since November 2021. Dow Jones Market Data says it was the hugest point and percentage gain for the small-cap index in a single week since November.
Dow Jones Market Data says that the Russell 2000 rose 1.1% on Friday and closed at its highest level since January 2022. During the day, it hit a new 52-week high.
Steve Sosnick, chief strategist at Interactive Brokers, said, “Perhaps the rally did signal the start of a breakout [for small caps]. When you’re at 52-week highs, you have to respect that.” “Small-cap stocks haven’t been able to keep going up for about a year now…” You could say that they are technically in a better position now.
Some investors bet earlier this year that small caps would have a big comeback in 2024 after a lacklustre year in 2023. They did this in the hopes that interest rates would go down and the economy would move towards a soft landing.
Indeed, the Russell 2000 has only gone up 6% so far this year, while the S&P 500 has gone up 17.7% and the Nasdaq Composite COMP has gone up 22.6% in the same time period.
There was a lot of hope for U.S. stocks this week because investors think the Federal Reserve will be ready to cut rates as soon as September.
In June, the consumer price index went down for the first time since the early days of the pandemic in 2020. This slowed the rate of inflation from the previous year to 3%. The core rate, which takes into account stable costs like food and energy, went up 0.1% from May to June. This pushed the annual rate of core inflation down to 3.3%.
This week, Jerome Powell, the head of the Federal Reserve, said that he would not be sending any signals about when future rate actions would happen. However, he did warn that easing policy restraints “too late or too little” could hurt the economy and jobs. Mary Daly, president of the San Francisco Fed, also said that the U.S. economy now shows that rates should be lowered.
The CME FedWatch Tool shows that traders in fed-funds futures have priced in a nearly 90% chance of a quarter-point rate cut in September. This is because of positive economic data and dovish comments from Fed officials.
Small-cap stocks tend to be more affected by changes in interest rates than their large-cap peers. They usually lose value when rates are thought to stay high for a longer time, but they gain value when there are signs that the central bank may be ending its cycle of tightening money.
Sosnick told MarketWatch in a phone interview on Friday that the recent outperformance in small-cap stocks was more of a “momentum-driven” broadening of the stock rally. He said this because macro catalysts didn’t do much to change “the viability of small-cap stocks in a meaningful way.”
“A 25-basis-point rate cut here and there doesn’t always make a difference for any group of stocks, let alone small caps,” he said. “There’s nothing we’ve seen that makes us think the economy is growing so fast that many of the Russell 2000 companies that people don’t like will actually start making money.”
According to Quincy Krosby, chief global strategist at LPL Financial, the Russell 2000 is seen as a key indicator for possible interest rate cuts. It is also a measure of the state of the economy.
She said that stocks in the small- and mid-cap categories usually fall “with the slightest suggestion of a material economic slowdown,” even if they are trading at low prices.
“The CPI report shows a hint of deflation, which goes along with the worry that the economy is slowing down more quickly, especially in the job market,” Krosby told MarketWatch over the phone on Friday. She said that because of this, there may not be a good reason for such a big shift towards small- and mid-cap names.
Most investors in the financial markets already think that the central bank could achieve a “soft landing” once it meets its inflation target. They want the Fed to cut rates because inflation is going down, not because the job market is getting worse. This is less likely to happen now that the economy is slowing down “at a faster clip,” Krosby said.
U.S. stocks went up at the end of the week on Friday. FactSet data shows that the S&P 500 went up 0.9%, the Nasdaq went up 0.3%, and the Dow Jones Industrial Average DJIA went up 1.6% in a week.
