View from the Observation Deck
In a previous post on this topic (click here), we noted that Jerome Powell’s July commentary to the Financial Services Committee on 7/10/24 appeared to have set the stage for a dramatic shift in the performance of small cap stocks relative to their large cap counterparts. Today’s post serves as an update to our previous observations. The chart above includes the price-only returns of the largest 100 stocks in the S&P 500 Index (the S&P 100 Index), the S&P 500 Index, and the S&P Small Cap 600 Index normalized to a factor of 100.
Takeaway: As noted in our previous post on this topic, smaller companies are often more reliant on outside capital than their larger counterparts, who generally operate in a state of going concern. Given that equity valuations can vary based on the cost of raising said capital (internally or externally), we expect further easing in monetary policy to have an outsized impact on small cap valuations relative to other market capitalizations. Another noteworthy point is that the spread between the federal funds target rate (upper bound) and the CPI remains well-above historical norms. We anticipate small cap valuations could benefit from a narrowing of that spread, over time. That said, there are mounting concerns that the Fed’s initial cut may have been too deep. Case-in-point: the Bureau of Labor Statistics announced that non-farm payrolls increased by 254,000 in September, well above the consensus expected 150,000. In the U.S., real GDP growth was unrevised at 3.0% in Q2’24, but Gross Domestic Income, an alternative measure of economic activity, was revised upward from 1.3% to 3.4%. Given the Fed’s data-dependency, a strong U.S. economic outlook may prove to be a headwind to small cap valuations.
This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions and other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 100 Index is a capitalization-weighted index based on 100 highly-capitalized stocks selected from the S&P 500 Index. The S&P 500 Index is an unmanaged index of 500 companies used to measure large-cap U.S. stock market performance. The S&P SmallCap 600 Index is an unmanaged index of 600 companies used to measure small-cap U.S. stock market performance.
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