Small-Cap Performance in 2024: Market Scaling Back Hopes for Interest Rate Cuts
Small-Cap Strategists Awaiting Rebound
As 2024 commenced, many stock strategists were eagerly harping for a rebound in small-cap performance. Optimism stemmed from the consensus belief that the Federal Reserve would initiate interest rate cuts during the first half of the year, reflecting potential market gains. However, recent market developments have damped these hopes, leading to a year-to-date decline of nearly 3% in the small-cap Russell 2000 Index. In contrast, the broader S&P 500 has recorded a gain of more than 5% thus far.
Bank of America’s head of US small- and mid-cap strategy, Jill Carey Hall, spoke to Yahoo Finance, explaining how small caps may face near-term challenges until further confirmation of inflation slowing and the Fed’s ability to implement rate cuts. Hall stated that small caps require greater clarity on the Federal Reserve’s interest rate path to truly progress.
Shift in Market Consensus
Market consensus has witnessed a significant shift from projecting seven rate cuts earlier in January to the current projection of two rate cuts this year, based on Bloomberg data. This shift has greatly dampened the prior rally in small caps, which persisted throughout 2023. Conversely, large-cap stocks have managed to hold onto their gains despite the evolving Fed narrative.
Debt Structures: A Crucial Distinction
A vital distinction lies in the debt structures of small-cap and large-cap companies. Bank of America’s research suggests that more than 40% of small caps carry debt that is exposed to higher rates, either in the form of floating-rate loans or short-term debt requiring refinancing in a higher rate environment. On the other hand, approximately 75% of S&P 500 companies possess long-term fixed-rate debt.
Moreover, larger companies often boast larger cash reserves, making higher rates potentially advantageous. In contrast, the non-reduction of rates by the Fed bears a greater cost for smaller companies. Hall notes, “The [Russell 2000] index is very sensitive to credit and rates. Refinancing risk is a key risk for these companies given that large caps were able to lock in a lot of long-dated fixed-rate debt. As rates remain high, that risk intensifies, impacting the earnings of smaller-cap companies.”
