Many equity strategists had been hoping for a turnaround in small-cap stocks since the beginning of the year, given the consensus that the U.S. 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% year-to-date, underperforming compared to the S&P 500 Index’s more than 5% gain this year.
“Until there is some certainty that inflation is slowing and that the Fed can start cutting rates, we think the Russell 2000 could be a little difficult in the near term,” Bank of America’s chief executive said. “There is,” 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 market consensus has shifted from expecting seven rate cuts this year in early January to two cuts this year, according to Bloomberg data. This move largely dampens small-cap gains heading into late 2023, while large-cap stocks continue to rally this year despite the change in the Fed narrative.
The main difference between the two is the company’s debt structure. Small-cap stocks have over 40% of their debt exposed to high interest rates, either in the form of floating rate loans that are exposed to current interest rates, or short-term debt that may need to be refinanced in a high interest rate environment. That’s compared to about 75% of the S&P 500 with long-term fixed debt, according to Bank of America’s research team.
In addition, large companies often have more cash reserves that could benefit from higher interest rates, meaning that the Fed’s failure to cut interest rates simply costs smaller companies more than large companies.
” [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…interest rates. The longer these remain high, the greater the risk to these returns. [smaller cap] companies. ”
