Small-Cap Stocks Are On Fire, But Is The Rally Sustainable?
Investors are increasingly flocking to small-cap stocks, fueled by optimism that these interest-rate-sensitive companies will thrive as the Federal Reserve prepares to cut interest rates. July has been a particularly strong month for small caps, with the Russell 2000 index surging nearly 9% month-to-date, significantly outperforming the tech-heavy Nasdaq 100, which is down 3.6% during the same period. This performance gap marks the best month for the "long small cap, short tech" trade since April 2002, highlighting the speed and strength of the ongoing market rotation.
Key Takeaways:
- Small-cap stocks are having a strong run: The Russell 2000 index is up nearly 9% in July.
- Investor interest in small-caps is surging: Major small-cap ETFs have seen significant inflows this month.
- Experts are divided on the sustainability of the rally: Some believe that the Fed’s potential rate cuts will benefit these smaller companies, while others suggest large-cap companies with more resources will ultimately prevail.
H2: The Small-Cap Rally: Fuelled by Investor Inflows
The impressive performance of small-cap stocks is mirrored by substantial inflows into major small-cap-focused ETFs. The iShares Russell 2000 ETF (IWM), one of the largest ETFs tracking the U.S. small-cap index, saw over $6 billion in net inflows this month, the highest influx of 2024 to date.
Several other small-cap ETFs have also attracted considerable investor funds this month, including:
- iShares Core S&P Small-Cap ETF (IJR): $645 million in net inflows
- Avantis U.S. Small Cap Value ETF (AVUV): $553.28 million in net inflows
- Invesco S&P SmallCap Momentum ETF (XSMO): $350 million in net inflows
- SPDR Portfolio S&P 600 Small Cap ETF (SPSM): $188 million in net inflows
For the year, the Vanguard Small-Cap ETF (VB) and the Pacer US Small Cap Cash Cows 100 ETF (CALF) have attracted the most investor money, with $3.1 billion and $2.9 billion respectively.
H2: A Different Perspective: Are Large Companies Still In The Lead?
Despite the strong performance of the Russell 2000 index and the substantial inflows into small-cap ETFs, some experts are urging caution.
Veteran Wall Street investor Ed Yardeni claims that while investors and analysts are optimistic about the future of smaller companies, particularly those reliant on debt financing, he remains unconvinced. Large companies, especially those in the tech sector, possess advantages that smaller firms cannot easily replicate.
One key advantage is that large tech companies are sitting on substantial cash reserves, enabling them to fund significant capital expenditures and R&D budgets, thereby maintaining their competitive edge. For example, Alphabet Inc. (GOOGL) had cash reserves of $111 billion at the end of last quarter, while Amazon.com Inc. (AMZN) and Microsoft Corp. (MSFT) have $87 billion and $80 billion respectively. This financial flexibility enables them to make strategic acquisitions of smaller companies with key new technology or business operations. Microsoft’s $10 billion investment in OpenAI, the developer of ChatGPT, last year perfectly illustrates this capability.
Yardeni argues that the fastest-growing, highest-potential companies may have already partnered with large-cap firms or private equity investors, implying that the laggards are left to trade in the S&P 400 and S&P 600, suggesting that investors might return to larger-cap alternatives sooner rather than later.
H2: The Future Of Small-Cap Stocks: A Tale Of Two Perspectives
The current bullish sentiment surrounding small-cap stocks is undeniably strong. The recent performance of the Russell 2000 shows investors’ eagerness to invest in this segment of the market. However, the sustainability of this rally remains a topic of debate. While some experts believe that a potential Federal Reserve rate cut cycle will boost smaller companies, others warn that large corporations, with their significant resources and strategic maneuvering capability, may ultimately maintain their dominance. Only time will reveal the true trajectory of small-cap stocks, but the market’s attention is firmly focused on them for now.
