The Fed Just Kicked the Door Open for Smaller Stocks

Five charts explain what's next. Published By Money & Markets, LLC. September 19, 2024 Published By Money & Markets, LLC. September 19, 2024 [Turn Your Images On] [Turn Your Images On] From The Desk of [Matt Clark, CMSA®]( Chief Research Analyst, [Money & Markets Daily]( The Fed Just Kicked the Door Open for Smaller Stocks Money & Markets Daily, The rate cut we’ve been waiting for is finally here. The Federal Open Markets Committee (FOMC) decided to cut its benchmark interest rate by a more aggressive 50 basis points during its two-day meeting, which concluded yesterday. Now that we know what the Fed will do, the script reverses to those anxious investors wondering what’s next. Good news… data points us in a solid direction after one of the largest rate-hike cycles in recent memory. And the answer to what's next might surprise you. If nothing else, it does point savvy investors in the direction of what they should do now that the Fed has started to reverse course. Let me explain… Rate Cooling Has Propped Up This Stock Class Before the FOMC approved its rate cut on Wednesday, interest rates were already starting to cool. That’s been reflected in a particular class of stocks in the market. And it’s not the same high-growth tech stocks that drove the market rally earlier this year. It’s small- and mid-cap stocks. [Turn Your Images On] In the last two months, the S&P Small-Cap 600 index has gained 2.6%, while the S&P Mid-Cap 400 index is up 1%. On the other hand, the tech-heavy Nasdaq Composite is down 7.4%, and the S&P 500 is off 2%. Here’s further proof of the correlation between interest rates and small-cap stock performance: [Turn Your Images On] When Treasury interest rates (yellow line) reached a peak in October 2023, the S&P Small-Cap 600 index (green line) hit its lowest point since January 2023. You can also see that when those interest rates start to come down, small-cap stocks rise. Considering that macro view, let's examine how small caps react in more favorable market environments. --------------------------------------------------------------- [Turn Your Images On]( [How to prepare for a Harris presidency]( Kamala Harris intends to carry on Biden’s legacy if she wins the elections…  [Take this simple step to protect and grow your wealth if she’s victorious.]( --------------------------------------------------------------- Small-Cap Fundamentals Improve With Lower Rates In general, when stock prices go up, earnings go up. Because the market looks at least 12 months into the future, consensus earnings-per-share growth is important to analyze. [Turn Your Images On] Estimates suggest that small- and mid-cap stocks have stronger earnings growth than the broader S&P 500. And these higher estimates are tied directly to lower interest rates. Smaller companies typically carry more debt than their large-cap counterparts. That debt is expensive to service … especially when interest rates are high. Lowering interest rates drops the cost of that debt for small companies and helps their bottom line. To show how well a business can pay interest on outstanding debt, we can look at its interest coverage — or earnings before interest and taxes divided by interest expense. The lower the interest coverage, the “harder” it is for a company to pay interest on debt: - S&P 500 — 7.8x. - S&P Mid-Cap 400 — 3.8x. - S&P Small-Cap 600 — 2.3x. Small- and mid-cap companies have more debt and less capital to pay it. But when interest rates fall, those multiples get better because the interest expense is lower. This is a signal for investors to look closer at small- and mid-cap stocks as rates fall. Their interest coverage gets better along with their earnings, resulting in an overall significantly stronger bottom line. Want more proof? [Turn Your Images On] Since 1999, small-cap stocks have experienced gains after their interest coverage hit below 2.6 — it’s at 2.3 currently. Six months after the interest coverage reached 2.6, small-cap stocks have gained an average of 14.3%. So, lower rates increase interest coverage and, thus, build up stock performance. The results are similar for mid-cap stocks: [Turn Your Images On] It may take a little longer, but mid-cap stocks have also experienced double-digit growth after interest coverage went below 3.8x. Similar to small caps, when interest rates drop, interest coverage for mid caps goes up along with the stock price. What It All Means: With interest rate cuts now in motion, small- and mid-cap stocks are poised to benefit in a big way. History shows these two classes of stocks reach double-digit share price growth between 6 and 12 months after reaching a low. The recent action by the FOMC could kick the door open to provide big gains for these stocks now … and in the immediate future. Until next time… Safe trading, [Matt Clark, CMSA®]( Chief Research Analyst, [Money & Markets Daily]( --------------------------------------------------------------- Check Out More From Money & Markets Daily: - [EVERYONE'S DOING THE INTEREST RATE BOOGIE]( - [THE #1 QUESTION ABOUT THE FED’S RATE CUT…]( - [COUNTDOWN TO RATE CUT DAY]( --------------------------------------------------------------- [Turn Your Images On]( Privacy Policy The Money & Markets, 702 Cathedral Street, Baltimore, MD 21201. To ensure that you receive future issues of Money & Markets, please add info@mb.moneyandmarkets.com to your address book or [whitelist]( within your spam settings. For customer service questions or issues, please contact us for assistance. The mailbox associated with this email address is not monitored, so please do not reply. 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To ensure that you receive future issues of Money & Markets, please add info@mb.moneyandmarkets.com to your address book or [whitelist]( within your spam settings. For customer service questions or issues, please contact us for assistance. The mailbox associated with this email address is not monitored, so please do not reply. Your feedback is very important to us so if you would like to contact us with a question or comment, please click here: [( Legal Notice: This work is based on what we've learned as financial journalists. It may contain errors and you should not base investment decisions solely on what you read here. It's your money and your responsibility. Nothing herein should be considered personalized investment advice. Although our employees may answer general customer service questions, they are not licensed to address your particular investment situation. Our track record is based on hypothetical results and may not reflect the same results as actual trades. Likewise, past performance is no guarantee of future returns. Certain investments carry large potential rewards but also large potential risk. Don't trade in these markets with money you can't afford to lose. Money & Markets permits editors of a publication to recommend a security to subscribers that they own themselves. However, in no circumstance may an editor sell a security before our subscribers have a fair opportunity to exit. Any exit after a buy recommendation is made and prior to issuing a sell notification is forbidden. The length of time an editor must wait after subscribers have been advised to exit a play depends on the type of publication. (c) 2024 Money & Markets, LLC. All Rights Reserved. Protected by copyright laws of the United States and treaties. This Newsletter may only be used pursuant to the subscription agreement. 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