Small Caps Show Resilience Amidst Economic Turbulence
Recently, small-cap stocks have been on a winning streak, celebrating their third consecutive week of gains. This upward momentum stems from a burgeoning investor confidence in interest rate-sensitive industries and businesses.
Investors are currently banking on a Federal Reserve rate cut in September, with market expectations pointing towards a 100% likelihood of this adjustment happening in the near future. What’s more, there’s talk of up to three rate cuts by the end of the year, fueling optimism in small-cap stocks.
This rising positive sentiment is also a result of the lack of immediate concerns about an economic slowdown, creating a favorable environment for small-cap investments to flourish.
Economic data released lately paints a rosy picture, with the U.S. economy expanding at a brisk 2.8% annualized pace in the second quarter, surpassing projections of a 2% surge. This growth rate has doubled compared to the first quarter. Notable easing in jobless claims has also been observed, alleviating worries about a sudden deterioration in labor market conditions.
As real growth numbers rise, inflationary pressures have significantly diminished. The latest figures show a drop in a widely monitored Federal Reserve inflation gauge to 2.5%, hitting its lowest mark since February 2021.
Over the past three weeks, small-cap stocks have surged by an impressive 11%, marking their most robust rally in three weeks since August 2022.
In the month of July alone, the iShares Russell 2000 ETF (IWM) attracted over $6 billion in inflows, making it the leader in attracting investments so far this year.
Assessment of Small Caps as Economic Indicators
Describing small caps as ‘an economic barometer,’ Quincy Krosby, chief global strategist at LPL Financial, underlines the impact of interest rate cuts on the surge of smaller stocks. These companies are more responsive to interest rate fluctuations compared to the S&P 500, especially when juxtaposed with the big tech corporations that have dominated the market throughout the year.
Krosby emphasizes that attractive valuations have further fueled this trend. The stability and gains observed in the broader financial sector have played a key role in supporting the Russell 2000, which is heavily influenced by small to mid-sized banks.
While acknowledging a cooling economy, Krosby asserts that a collapse is not looming on the horizon. Continual investor interest in small-cap stocks amidst political and economic uncertainties signifies trust in a solid economic backdrop coupled with expected lower interest rates.
However, Krosby also warns that small-cap stocks, being riskier compared to the S&P 500, are susceptible to swift sell-offs if there’s a perceivable shift in the economic trajectory.
Looking ahead, the upcoming week is set to focus on a plethora of economic data, including the payroll report, factory orders, the FOMC meeting, and crucial technology earnings reports. These factors are expected to sustain the small-cap sector’s resurgence.