After the Federal Reserve issued a rate cut signal, the Russell 2000 small cap stock index has risen nearly 15% since the beginning of this month, significantly leading the three major indexes. After experiencing a sustained downturn in recent years, many institutions are optimistic about the performance of small cap stocks in the loose cycle stage. This year, star technology stocks represented by artificial intelligence will shine brightly, and whether the hot topics will rotate in 2024 will become a major focus of the market.
Technical indicators suggest that breakthroughs are imminent
After experiencing a long period of downturn, the year-end rise of small cap stocks began to gradually attract market attention.
Research firm Renaissance Macro released a report this week stating that the 50 day moving average of the Russell 2000 benchmark index for small cap stocks in the United States is approaching its 200 day moving average. This is often seen as one of the significant indicators of a positive long-term trend in assets.
Compared to two months ago, this represents a significant emotional shift. At that time, while the NASDAQ 100 index hit a historic high, the ratio of the Russell 2000 index to it hit a new historical low.
Analysts say that the sustained surge in small cap stocks in 2024 will depend on how the Federal Reserve handles its key interest rates next. Since 2022, the Federal Reserve has raised interest rates a total of 11 times, and the federal funds rate has reached a new high since 2001.
According to data from the Chicago Mercantile Exchange's FedWatch tool, traders are currently pricing a total of 150 basis point rate cuts for 2024, with the first rate cut expected in March 2024, which is much more optimistic than the Federal Reserve's expected 75 basis point rate cut.
Small cap companies are more sensitive to interest rates because their balance sheets are often more fragile, with higher debt pressure and less fixed rate debt compared to large cap companies. Tom Hainlin, global investment strategist at Ascent Private Capital Management, said that the average debt maturity of large cap companies is about 11 years, while that of small cap companies is 5.5 years.
According to Dow Jones market data, the performance of the small cap stock barometer this month was nearly 10 percentage points better than that of the S&P 500 index, setting the best performance since February 2000.
Years of weakness are expected to reverse
Francis Gannon, Co Chief Investment Officer of Royce Investment Partners, believes that the end of interest rate hikes, cooling inflation, strong labor markets, and stable consumer spending may continue to boost the performance of small cap stocks.
Historical data also supports this. He summarized and found that in the five years ended September 30th, the annualized return rate of the Russell 2000 Index was 2.4%, which is one of the lowest five-year returns since the establishment of the index. However, when there is a situation where the return rate is below the average level for five years, the return rate for the following five years can reach 14.9% if it remains above the average level. Gan Nong stated that this is much higher than the five-year rolling return rate of 10.4% since the establishment of the index.
Mike Wilson, Chief Investment Officer and US Equity Strategy Analyst at Morgan Stanley, said that the Federal Reserve's policy shift is "good news for the stock market", which means that the Federal Reserve is starting to focus more on economic growth rather than worrying about whether the decline in inflation can be sustained. This will increase the possibility of a soft landing, which will drive small cap stocks and other sectors that have underperformed the market this year to enter a rebound market.
Tom Lee, the head of research at Fundstrat, is one of the most bullish analysts on small cap stocks on Wall Street. He predicts that Russell 2000 will climb 50% in the next 12 months and may reach 3000 points by the end of 2024. "If the Federal Reserve stops such aggressive interest rate policies, investors will see (small cap stocks) concerns resolved in the next 12 months." He believes that small cap stocks with higher leverage will benefit more from rate cuts.
Haiyinglin, global investment strategist at Ascent Private Capital Management, believes that further evidence of a soft landing is needed in the future to support a sustained upward trend in stock prices. "If the market experiences a decline in corporate profits or a cooling of consumer spending in 2024, small cap stocks may perform poorly," he said.
Zachary Hill, Head of Portfolio Management at Horizon Investments, said it is important to observe the profits of small cap companies in the first quarter of next year to determine whether this rebound is sustainable. "Cheap prices are not a bullish reason," Hill wrote. "The first quarter financial report season and guidelines are a potential catalyst that may confirm the rebound seen so far and may also lead to some investors repositioning."