Small-cap stocks typically outperform large caps after 50 bp Fed rate cut — BofA

Small-cap stocks, on average, outperform their large-cap peers after a 50-basis-point rate cut by the Fed, according to Bank of America (BofA). Last week, the Fed lowered the fed funds rate for the first time since 2020.

Details

History suggests that small caps, on average, return a percentage point more than large caps in the six months after a Fed rate cut of 50 basis points and about three percentage points more in the 12 months following such a cut, Barron’s reports citing Jill Carey Hall, head of U.S. small- and mid-cap strategy at BofA.

The Fed cut rates by 50 basis points on September 18, easing monetary policy for the first time since 2020 and triggering a rally in stocks. The small-cap-tracking Russell 2000 index has climbed 1.0% since the decision, while the large-cap S&P 500 has gained 1.2%.

Context

Investors began partially rotating out of big tech stocks and into small caps back in the summer, amid indications of slowing economic growth and expectations of a rate cut. As a result, for the month of July, the Russell 2000 beat the Nasdaq Composite, an index comprising large tech stocks, by the widest margin since 2001.

The logic was simple: lower borrowing costs should translate into an increase in the value of smaller companies, notes Barron’s. About 40% of the debt that nonfinancial Russell 2000 companies owe is floating rate, Hall of BofA notes, whereas for S&P 500 companies, most of the debt is fixed rate.

Analysts are likely to raise their forecasts for smaller companies, factoring in reduced debt-servicing costs that could give their share prices a boost, Barron’s adds.

“Given the valuation discount, [potential] earnings growth and the cyclical nature of the small-cap stocks, the Fed starting to cut this week could very well serve as a catalyst to get investors interested in small-cap companies,” Matt Palazzolo, a senior investment analyst at Bernstein Private Wealth Management, told MarketWatch recently. Sean Gallagher, the global head of the small-cap equity platform at Lazard, also noted that small caps could rally 30-50% in the next 6-12 months.