Small-cap stocks bolstered by possibility of interest rate cuts (2024)

While election news dominated July's headlines, small-cap stocks had their best monthly performance relative to large-cap stocks since December 2000.

Election news dominated headlines through July and culminated in President Joe Biden declining to seek a second term, instead endorsing Vice President Kamala Harris as the Democratic Party’s candidate. The markets don’t particularly like uncertainty, but the turbulence that followed this commotion is not likely to linger as more fundamental market forces play out.

“Politics is only one of ten factors in our equity outlook framework and in fact, it ranks pretty far down the list,” said Raymond James Chief Investment Officer Larry Adam. “Macro factors and fundamentals are much more important in determining the market’s direction.”

The market’s expectations have been on a rollercoaster regarding the Federal Reserve (Fed) cutting interest rates this year, but with inflation receding and consumer spending beginning to slow, lower rates seem finally in sight. This has bolstered small-cap stocks, which had their best monthly performance in July relative to large-cap stocks since December 2000*.

Historically, small caps outperform in anticipation of and following a first rate cut, and this rally is supported by improvements to corporate earnings. Earnings are on track to rise 10% year over year, turning in the best quarter since the fourth quarter of 2021. Real estate and financials were the best performing sectors. Tech-related sectors underperformed.

Bond yields were lower across the board, led by shorter-term securities, as markets priced in the likelihood of a rate cut.

Employment remained strong in June, with the establishment employment survey showing jobs increasing by 206,000, but the unemployment rate – which comes from the household survey – inched up to 4.1% from 4.0%.

We’ll dig into the details below, but first we’ll look at the numbers year-to-date:

12/29/23 Close

7/31/24 Close*

Change
Year to Date

Gain/Loss
Year to Date

DJIA

37,689.54

40,842.79

+3,153.25 +8.37%

NASDAQ

15,011.35

17,599.40

+2,588.05 +17.24%

S&P 500

4,769.83

5,522.30

+752.47 +15.78%

MSCI EAFE

2,241.21

2,340.81

+99.60 +4.44%

Russell 2000

2,027.07

2,254.48

+227.41 +11.22%

Bloomberg U.S.
Aggregate Bond Index

2,162.21

2,184.96

+22.75 +1.05%

*Performance reflects index values as of market close on July 31, 2024. Bloomberg Aggregate Bond and MSCI EAFE reflect July 30, 2024, closing values.

Market volatility amidst earnings season

The S&P 500, which measures the aggregate performance of the largest U.S. companies, rallied at the end of the month and finished July up 1.2% – within the range of a normal market adjustment. Showing just how starkly market sentiment has shifted, the Russell 2000, which measures the performance of small U.S. companies, returned 9.8% last month.

Earnings season has been as expected so far, with 79% of companies beating earnings by an average surprise of 4.4% – a deceleration from the 7.8% surprise of last quarter.

Treasury yields dropping in anticipation of rate cuts

Treasuries rallied in July, taking yields lower for the month with shorter-term yields falling more than longer yields (the 2-year yield dropped around 34 basis points while the 30-year fell by nine). The curve remains inverted, but with decreased depth – the spread on the two-year/10-year curve, which has been inverted since July 2022, moved from negative 36 basis points to negative 20.

Bloomberg calculations are now pricing in a 25-basis point cut to the fed funds rate in September and another one to two by the end of the year, a sentiment reflected in short-term yields with the one-year Treasury falling by more than 40 basis points since April.

CPI shows first deflationary month in four years

Second-quarter GDP growth came in above consensus at 2.8% annualized, quarter-over-quarter. The economic growth, however, didn’t put more pressure on prices, indicating the higher-than-expected inflation readings of the first quarter were likely one-offs.

Inflation, as measured by the Consumer Price Index (CPI) was lower than expected, declining by 0.1% – the first deflationary month since May 2020 – while the year over year rate dropped to 3.0%. Important data from the report to note is the slowdown in shelter costs, which, if sustained, will continue to put downward pressure on the CPI for the remainder of the year, which would be good news for the Fed and the path of monetary policy.

Watching November's election take shape

After last month’s shakeup, the markets will be closely monitoring the Democratic National Convention for indications of Vice President Harris’ policy priorities. While her platform is expected to largely align with that of the Biden administration, important nuances will likely be clarified around the convention.

Former President Donald Trump’s selection of Ohio senator JD Vance as running mate was a key development in July, especially given the importance Trump has historically placed on the policy input of his vice president. Vance’s selection seems to confirm an aggressive trade agenda, especially toward China, would continue under a second Trump administration.

Interest rate cuts in Europe, Canada and China; Bank of Japan hikes rates

July’s European elections delivered divergent outcomes in France and the U.K., with the host nation of the summer Olympics seeing political fragmentation that could lead to further fiscal policy turbulence. The new U.K. administration, on the other hand, should provide financial markets with a more predictable agenda and a commitment to fiscal discipline.

The European Central Bank, having cut interest rates in June, will be monitoring the French government closely to prevent market conditions from further deterioration.

The Bank of Canada has also cut interest rates – as expected, and for a second successive time – while signaling there may be more cuts in the pipeline, which could allow the economy to grow without risking more inflation.

In response to the conclusions reached at the Chinese Communist Party’s Third Plenum, the People’s Bank of China cut interest rates for the first time since last summer, providing some reassurance that policymakers and the central bank are taking action to prevent further slowdowns in economic momentum.

The Bank of Japan (BOJ) continues to buck the global easing trend, raising its key interest rate for the second time this year to 0.25% and announced a reduction in its bond buying program. The move signals the BOJ’s growing confidence in the recovery.

Iranian election's potential impact on oil prices

The most important election last month as it relates to the energy sector was Iran’s. Newly elected President Masoud Pezeshkian ran on a platform of domestic reform and more engagement with the international community. Iranian foreign policy tends to fall within the purview of the Supreme Leader rather than the president, but more pragmatic diplomacy could reduce tensions and the geopolitical risk premium in the oil market. An important test case emerged at the very end of the month, after the political leader of Hamas was killed in Tehran, presumably by Israel. If the Iranian government shows restraint, it would help to avoid further escalation and minimize the risk of all-out war with Israel.

The bottom line

The volatility we’re seeing isn’t entirely unexpected, considering we’ve seen only one 5% pullback in the S&P 500 so far in 2024 when we typically see three or four per year – not to mention the uncertainty around the presidential election. Now that we’re in the weakest seasonal period of the year, caution is warranted, but this is why we invest long-term.

Investing involves risk, and investors may incur a profit or a loss. All expressions of opinion reflect the judgment of the authors and are subject to change. There is no assurance the trends mentioned will continue or that the forecasts discussed will be realized. Past performance may not be indicative of future results. Economic and market conditions are subject to change. The Dow Jones Industrial Average is an unmanaged index of 30 widely held stocks. The NASDAQ Composite Index is an unmanaged index of all common stocks listed on the NASDAQ National Stock Market. The S&P 500 is an unmanaged index of 500 widely held stocks. The MSCI EAFE (Europe, Australasia and Far East) index is an unmanaged index that is generally considered representative of the international stock market. The Russell 2000 is an unmanaged index of small-cap securities. The Bloomberg Barclays US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market. An investment cannot be made in these indexes. The performance mentioned does not include fees and charges, which would reduce an investor’s returns. International investing involves special risks, including currency fluctuations, differing financial accounting standards, and possible political and economic volatility. Investing in oil involves special risks, including the potential adverse effects of state and federal regulation and may not be suitable for all investors.U.S. government bonds and Treasury notes are guaranteed by the U.S. government and, if held to maturity, offer a fixed rate of return and guaranteed principal value. U.S. government bonds are issued and guaranteed as to the timely payment of principal and interest by the federal government. Treasury notes are certificates reflecting intermediate-term (2 -10 years) obligations of the U.S. government. Companies engaged in business related to the technology sector are subject to fierce competition and their products and services may be subject to rapid obsolescence.MAGMAN stocks is a term used to describe six of the current largest and least volatile technology companies listed on the NASDAQ – Microsoft, Apple, Google, Meta, Amazon and Nvidia.

Material created by Raymond James for use by its advisors.

Small-cap stocks bolstered by possibility of interest rate cuts (2024)

FAQs

Small-cap stocks bolstered by possibility of interest rate cuts? ›

Historically, small caps outperform in anticipation of and following a first rate cut, and this rally is supported by improvements to corporate earnings. Earnings are on track to rise 10% year over year, turning in the best quarter since the fourth quarter of 2021.

How does inflation affect small-cap stocks? ›

1. U.S. small‑cap companies have tended to outperform their larger counterparts during periods of heightened inflation and rising interest rates. 2. Following periods of economic recession, U.S. small‑cap companies have generally led the market recovery—often going on to outperform larger companies over multiple years.

What is a small-cap stock and why might someone consider investing in a small-cap stock? ›

The general definition of a small-cap is a stock with a market cap between $300 million and $2 billion. The small-cap segment typically has less liquidity and potentially less financial stability than large-caps (which have market caps above $10 billion).

Why a small-cap stock is more likely to be a growth stock rather than an income stock? ›

And because they are smaller, small-cap share prices have a greater chance of growth. 1 This means they have more potential for investors to earn money faster. In general, small-cap stocks are thought to be more volatile than big-cap stocks and thus provide both greater risk but also opportunity.

What stocks to buy when interest rates rise? ›

Stocks to Watch When Rates Rise
CompanyTickerIndustry
Goldman SachsGSFinancial (Investment Banking/Brokerages)
CitigroupCFinancial (Banking)
Charles SchwabSCHWFinancial (Investment Banking/Brokerages)
AllstateALLInsurance
10 more rows

Are rate cuts good for small-cap stocks? ›

Small-cap stocks are another asset class that tends to do well when interest rates are lower.

Will small-cap stocks do well in 2024? ›

We believe SMID-cap companies will continue to deliver strong earnings growth. Our 2024 Long-Term Capital Market Assumptions estimate that U.S. SMID-cap equity returns will be robust over a 10-to-15-year investment horizon, even rivalling that of U.S. large caps (albeit with more risk).

What are the problems with small-cap stocks? ›

Smaller companies tend to be more labor intensive than large companies, so if the cost of labor increases during a period of increased inflation, small-cap company profits could be at risk.

Which is the best small-cap stock to buy now? ›

List of Best Small Cap Shares to Invest
NamePriceNet Profit Qtr
J B Chemicals & Pharmaceuticals Ltd₹1,915.85₹126 Cr
Aarti Industries Ltd₹751.10₹132 Cr
360 ONE WAM Ltd₹1,003.15₹244 Cr
Endurance Technologies Ltd₹2,487.90₹210 Cr
12 more rows

Is it good to invest in small-cap now? ›

If you are investing in mutual funds for a short duration, stay away from small-cap mutual funds. Small-cap mutual funds perform well over a long period of time. However, over a short period of time, they tend to be very volatile.

Are small-cap stocks high risk? ›

Small caps refer to companies with a market capitalization ranging from $300 million to $2 billion. The stocks of small caps are prone to wide market fluctuations; hence, these are highly risky investments.

Why trade small-cap stocks? ›

The primary advantage of investing in individual small-cap stocks is the significant upside growth potential that is unmatched by larger companies. Small-cap value index funds also offer a way for passive investors to boost returns. Merger and acquisition activity provides another opportunity for small-cap investors.

Do small-cap stocks outperform in a recession? ›

Putnam Investment Management, however. “If you look at history what you learn is that small caps only outperform when we're exiting a recession and that's because they're very cheap. They've been left for dead, and as we exit a recession, the economy accelerates,” said Hazen.

What stocks benefit from rate cuts? ›

Those include:
  • Growth stocks. As mentioned before, lower rates typically benefit growth stocks by reducing borrowing costs and increasing the present value of future earnings. ...
  • High-yield bonds. ...
  • Real estate investment trusts (REITs). ...
  • Preferred stocks. ...
  • Dividend-paying stocks.
Jun 28, 2024

Will stocks go down if interest rates go up? ›

When interest rates are rising, both businesses and consumers will cut back on spending. This will cause earnings to fall and stock prices to drop. On the other hand, when interest rates have fallen significantly, consumers and businesses will increase spending, causing stock prices to rise.

What happens to stocks when the Fed cuts rates? ›

Stocks have typically risen in the six- to 12-month period following the Fed's first rate cut, as long as the economy avoids recession, Truist's research showed. Lower interest rates could also help broaden the equity rally, which has been led by a handful of megacap companies like Nvidia (NVDA.

Do small-cap stocks do well in a recession? ›

Investing in small caps during recessions has generated superior investment returns, according to our back-testing of the data to the late 1980s (see Table 1, below).

Will small caps recover? ›

“Our expectation is that this dynamic will begin to reverse itself later this year as small-cap profits continue to recover via back-end loaded growth in 2024 and into 2025.”

Why is the small-cap market falling? ›

Market experts are anticipating a potential slowdown in the mid and small-cap segments due to their high valuations, which may have reached unsustainable levels.

Top Articles
Latest Posts
Recommended Articles
Article information

Author: Pres. Lawanda Wiegand

Last Updated:

Views: 5287

Rating: 4 / 5 (71 voted)

Reviews: 94% of readers found this page helpful

Author information

Name: Pres. Lawanda Wiegand

Birthday: 1993-01-10

Address: Suite 391 6963 Ullrich Shore, Bellefort, WI 01350-7893

Phone: +6806610432415

Job: Dynamic Manufacturing Assistant

Hobby: amateur radio, Taekwondo, Wood carving, Parkour, Skateboarding, Running, Rafting

Introduction: My name is Pres. Lawanda Wiegand, I am a inquisitive, helpful, glamorous, cheerful, open, clever, innocent person who loves writing and wants to share my knowledge and understanding with you.