Small-Cap Stocks Surge for Third Straight Week, Fueled by Rate Cut Optimism and Strong Economic Data
Small-cap stocks have rallied for the third consecutive week, driven by a confluence of positive factors. Investor optimism towards interest rate-sensitive industries and companies is soaring based on firm expectations of a Federal Reserve rate cut in September. This optimism is further strengthened by the absence of fears over an imminent economic slowdown, creating a landscape particularly favorable for small-cap stocks, which are often more sensitive to such shifts.
Key Takeaways:
- Rate Cut Expectations: Markets are currently pricing in a 100% probability of a Fed rate cut within the next two months, with forecasts for nearly three cuts by year-end.
- Strong Economic Data: The US economy expanded its output at a 2.8% annualized pace in the second quarter, exceeding expectations and doubling the performance from the first quarter. Jobless claims also eased last week, easing concerns about a rapid cooling in labor market conditions.
- Inflation Easing: The Personal Consumption Expenditures (PCE) price index, a widely followed inflation gauge, dropped to 2.5% last month, its lowest level since February 2021.
- Investor Confidence: The iShares Russell 2000 ETF (IWM), a popular small-cap benchmark, attracted over $6 billion in inflows in July, marking its largest inflow year-to-date.
- Small Caps as Economic Barometer: Quincy Krosby, chief global strategist for LPL Financial, suggests that small caps serve as an "economic barometer" and their recent surge reflects investor confidence in a solid economic backdrop, bolstered by anticipated lower interest rates.
A Look at the Driving Forces
Rate Cut Expectations
The market’s expectation of a September rate cut by the Federal Reserve is central to the recent rally in small-cap stocks. Notably, the CME Group’s FedWatch tool indicates a 100% likelihood of a rate cut within the next two months, and an increasing likelihood of multiple cuts by year-end.
This anticipated easing of monetary policy is particularly beneficial for small-cap businesses, which tend to be more sensitive to interest rate changes than larger companies. Lower rates can make borrowing more affordable, stimulating investment and growth for smaller businesses.
Strong Economic Data
Economic data released this week provided additional support for the bull run in small-cap stocks. The U.S. economy recorded a 2.8% annualized growth in the second quarter, comfortably surpassing estimates and demonstrating a significant improvement from the first quarter’s performance. This robust growth suggests a healthy economic environment that can sustain company performance.
Simultaneously, a decline in jobless claims last week further cemented the positive outlook. This indicator suggests that the labor market remains relatively robust, mitigating concerns of an impending economic slowdown.
Easing Inflation
The continued decline in inflation is also contributing to the positive sentiment surrounding small-cap stocks. The PCE price index, a key inflation metric closely watched by the Federal Reserve, fell to 2.5% last month. This drop, reaching the lowest level in over two years, further bolsters the expectation of a rate cut and reinforces the belief that economic stability is taking root.
Perspective from Experts
Quincy Krosby, chief global strategist for LPL Financial, emphasizes the significance of small-cap stocks as a reflection of economic health. She believes the recent surge in these stocks points to a confident investor outlook. The influx of capital into small-cap focused funds, like the iShares Russell 2000 ETF (IWM), indicates strong investor confidence in these sectors.
While acknowledging the positive indicators, Krosby also cautions that small-cap stocks carry a higher risk profile compared to the S&P 500, given their greater sensitivity to market shifts. Investors are advised not to lose sight of the potential for volatility in these stocks, especially if economic conditions change abruptly.
Looking Ahead
The coming week promises continued momentum in the small-cap market. Investors will be closely watching key economic data releases, including the payroll report, factory orders, and the Federal Open Market Committee (FOMC) meeting, for insights into the trajectory of the US economy and potential further rate cuts. Additionally, key technology company earnings reports will also be carefully considered.
Small-Cap Renaissance: A Potential Opportunity
The bullish outlook for small-cap stocks presents a potential opportunity for investors seeking exposure to growth stocks. While this rally is supported by positive economic data and anticipated rate cuts, it’s crucial to remember that these stocks are inherently riskier than their large-cap counterparts. Investors should carefully assess their risk tolerance and diversify their portfolios accordingly.
The current momentum in small-cap stocks suggests a potential for continued growth in the coming months. However, investors need to monitor economic developments, interest rate decisions, and potential market volatility to capitalize on this opportunity wisely.
