Interest Rate Cuts Trigger Small Stock Leadership
The Russell 2000 small-cap index outpaced the S&P 500 as the stocks benefit from a change to interest rates.
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After years of lagging, it looks like the Russell 2000 may finally be in the spotlight.
Smaller stocks tend to be more sensitive to interest rates because they typically carry more debt than their big-cap cousins. Stocks like Apple AAPL and Microsoft MSFT have relatively small amounts of debt on their balance sheets, and when they do have debt, they will receive the best terms.
Small caps can gain a substantial boost to their bottom lines when their interest rates are lower and they have an easier time acquiring the loans they need. They are viewed as the biggest beneficiaries of a dovish Fed and a series of interest rate cuts.
The Russell 2000 small-cap index IWM gained 2.5% on Thursday and is at an all-time closing high. That compares to the S&P 500, which is also at an all-time high but only gained 0.5%. The Magnificent Seven was equally tepid with a 0.5% gain.
The strength in smaller caps is reflected in breadth. Over 70% of stocks were in the green, and the majority of them were smaller names.
What is most interesting about the small-cap strength is that they have lagged the big caps for years. Market strategists and pundits have periodically predicted a cycle with rotation into small stocks, but it never seems to develop. There have been a few periods where the Russell has outperformed, but it never lasts long.
This time, the conditions are a bit different. Not only do interest rates favor smaller stocks, but many of them are not as expensive or as technically extended as the big caps that have led the market for so long.
In the near term, the action is a bit frothy, but conditions are good for this small-cap leadership to continue. Benefitting from small caps is all about being a good stock picker. You must be selective and stick with the names that have the best price action. They can produce much greater returns than the big caps, but that comes with the price of greater volatility and more risk.
We will see how things develop, but things look bright for the little guys.
Have a good evening. I’ll see you tomorrow.
At the time of publication, DePorre had no positions in any securities mentioned.
