Mitch Zacks: Why Small Caps Lagged Earlier in 2024—and Pulled Back More in April

Mitch offers a “small” insight into what’s behind April’s market volatility, and why small-caps are down but not necessarily out. [Mitch on the Markets] A “Small” Insight on April’s Stock Market Volatility Equity markets have experienced downside volatility in April, following the strong rally that started last October and continued through the first quarter. In looking more closely at trends across sectors, sizes, and styles, investors may have noticed that small-cap stocks have struggled to gain footing, particularly when compared to large-caps and especially when compared to large-cap growth stocks. Since the bottom of the pandemic bear market in March 2020 through the end of Q1 2024, for instance, small-cap growth stocks are up 101.2%, while large-cap growth stocks are up 165.8%. This performance gap seems to be persisting more recently. The Russell 2000 Index (small caps) rose 5.2% in the first quarter compared to the S&P 500’s 10.6% gain, and small caps have also fallen more during April’s pullback. As I write, the Russell 2000 Index is down around -8% for the month, compared to the S&P 500’s -5% decline. One might expect outperforming stocks to shed more on the downside, but that hasn’t been the case with small caps vs. large caps.1 So, what’s holding small caps back in the current environment? In a word, the Fed. As many readers know, the Federal Reserve has dialed back expectations for rate cuts in 2024, with the market now expecting less than two rate cuts in 2024—down from six to start the year. The return to the ‘higher for longer’ interest rate policy arguably hurts small-cap stocks more than it does large-caps. Big companies with healthy balance sheets have easy access to bond markets, and many took advantage of the era of low rates to lock in debt at attractive rates. Many large-cap companies are also flush with cash. --------------------------------------------------------------- [Will Market Volatility Collide with Rising Commodity Prices?]( The stock market has experienced downside volatility in April. Meanwhile, commodity prices have been going up, and that’s causing inflation concerns. Until this year, commodity prices have generally been in decline—following the pandemic and war-induced supply and demand shocks that sent prices soaring. But now, prices are climbing again, just as inflation is becoming worrisome and the Federal Reserve has retreated from its plans for cutting rates in 2024. If commodity prices keep going up and push broader inflation higher as well, the outlook for the economy and markets could look much different than it does today. To help investors understand these issues, we’re offering our [April 2024 Zacks Market Strategy Report 2]( at no charge. Don’t miss this report to get the latest on the economy, markets, and more including: - Commodities are Rallying – Sign of Strength or Weakness? - Making the Case for Bank Stocks - Bottom Line for Investors - ...and much more! If you have $500,000 or more to invest and want ideas on how to invest in a strong market, click on the link below to get your free report today! [IT’S FREE. Download the April Market Strategy Report 2]( --------------------------------------------------------------- It tends to be the opposite for small caps. Small companies do not have the same easy access to bond markets, and many often don’t sit on piles of cash as they’re often too focused on investing and growing. This setup tends to translate into many small-caps borrowing at floating versus fixed rates, meaning that a period of rising interest rates can substantially raise costs. Consider that about 30% of debt held by Russell 2000 companies is floating, versus about 6% for S&P 500 companies. Investors are less optimistic that the borrowing environment will improve substantially in 2024 for small caps, and that’s created some selling pressure. This is perhaps most evident when comparing changes in the Russell 2000 Index to changes in the 10-year U.S. Treasury bond yield. Generally speaking, as yields go up, small-cap stocks have gone down. Does this mean the outlook for small-cap stocks is decisively negative for 2024? I think not. In my view, the Fed’s recent shift doesn’t change the notion that this interest rate cycle has peaked. With fed funds currently in a range between 5.25% and 5.5% and CPI at 3.8% (and the Fed’s preferred PCE price index at 2.5%) policy is already quite restrictive. Even a slight bump higher in inflation from here would not necessarily mean rate hikes and cuts are very much still on the table. If the U.S. economy is strong and the outlook is that rates will be lower in the future than they are today, that’s a constructive setup for small-cap stocks. Finally, there’s the matter of valuations. Because large-cap growth stocks have had an impressive run especially relative to small-cap stocks, there’s a valuation gap that makes small-cap stocks look inexpensive on a relative basis. As of the end of Q1 2024, for instance, small-cap value stocks were trading at 103% of their 20-year average P/E, while large-cap growth stocks were trading at 147% of 20-year P/E averages. If rate cuts do come and the U.S. economy continues to surprise to the upside, small-caps could easily lead again. Bottom Line for Investors Zooming out from the discussion of small-caps, I think it is important for investors to take a moment to think about recent downside volatility and what it means for investment strategies looking ahead. The key thing to remember, in my view, is that even though the financial media will toil over assigning attribution to downside market volatility, the reality is that short-term pullbacks can happen for any number of reasons. They are an intrinsic part of equity investing. Since 1980, the average intra-year decline for the S&P 500 is -14.3%, which tells us that downside volatility is not an anomaly of equity investing—it’s a feature. During the eleven-year bull market that lasted from 2009 to 2020, there were a total of nine corrections. Pullbacks are normal. The issue that often troubles many investors – and ultimately hurts them – is that they let volatility increase their temptation to “time the market,” allowing short-term uncertainties to drive their decision-making. Don’t fall into this trap. To better navigate through today’s market, I recommend downloading our free [April 2024 Market Strategy Report 3](. This report shares our expert market commentary and the latest forecasts on: - Commodities are Rallying – Sign of Strength or Weakness? - Making the Case for Bank Stocks - Bottom Line for Investors - ...and much more! If you have $500,000 or more to invest and want to learn more about our market forecasts for 2024, click on the link below to get your free report today! [Claim Your Free Report]( About Zacks Investment Management Zacks Investment Management was born out of one of the country’s largest providers of independent research, Zacks Investment Research. Our independent research capabilities from our parent company truly distinguish us from other wealth management firms - our strategies are derived from research and innovation, including the proprietary Zacks Rank stock selection model, earnings surprise and estimate revision factors. 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