Goldilocks might be on to something.
Investors have been busy over the past week trying to figure out how best to deal with the Federal Reserve’s decision to cut interest rates for the first time since 2020.
I asked several strategists which stocks stand to benefit the most going forward. Surprisingly, it’s not large- or small-cap stocks, but two trades that have dominated market headlines in recent months. In fact, often forgotten mid-cap stocks may be best positioned for a breakout.
“Historically, when the Fed actually starts cutting rates, mid-cap stocks really start to outperform,” Ryan Detrick of Carson Group told me.
Detrick sees mid- and small-cap stocks rising as much as 20% over the next 12 months, far outperforming their large-cap peers. The small-cap index Russell 2000 (^RUT) is up 10% since the end of June, compared to a 4.7% rise in the S&P 500 index (^GSPC).
A recent analysis by Goldman Sachs found that mid-cap stocks typically outperformed large- and small-cap stocks in the 12 months following the first rate cut. As confidence in soft landings grows, investors are becoming more comfortable reaching out to options outside of large companies.
“The start of the Fed’s rate cutting cycle is a potential source of increased demand for stocks and a boost in investor risk sentiment,” Goldman Sachs’ Jenny Ma wrote in a note to clients earlier this month. . “In the near term, mid-cap performance relative to other segments will depend on the strength of economic growth data and the pace of the Fed’s easing cycle.”
The team sees low valuations and solid economic growth as catalysts for future gains, and expects the S&P 400 Index (^SP400) to return 13% over the next 12 months.
Emily Rowland, co-chief investment strategist at John Hancock Investment Management, said: “The earnings context is on another planet, so this is a sentiment-driven market rotation based on expectations of a soft landing, and the market’s “It will bring benefits to the areas with the highest risk.”
Bank of America’s Jill Carey Hall says mid-cap stocks are “the best hedge” in the short term.
“Mid-cap stocks have improved in recent guidance and revision trends, outperforming small-cap stocks on average during economic downturns, and given small-cap stocks’ interest rate sensitivity and refinancing risk, they have been able to outperform the Fed’s expectations. It is acting as a hedge against lower interest rate cuts,” Hall wrote. Note to client
Investors are pricing in a rate cut of about 75 basis points by the end of the year, and see rates falling to a range of 3.00-3.25% by mid-2025, higher than the Fed’s own expectations.
But remember, this is nothing new to Wall Street. Wall Street had been pricing in about six rate cuts in 2024 since the beginning of the year.
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Small-cap stocks tend to have weaker balance sheets and lower profitability, so the risk of a slowing Fed rate cut cycle and concerns about a prolonged recession are key drivers of the recent shift away from small-cap and mid-cap preferences. It has become.
Brian Jacobsen, chief economist at Annex Wealth Management, said small-cap trading “could become more difficult before it becomes more attractive” and that “concerns about slower growth could outweigh the benefits of lower borrowing costs.” It’s very sexual,” he said.
Citi’s Stuart Kaiser was also cautious about the deal, telling me that investors should approach the group with “very caution”.
“Our view is that even if we get a soft landing, we’re going to get a lot of worse data. “We’re going to have a hard landing in early August,” Kaiser warned. “Small-cap stocks will be the eye of the typhoon in this regard.”
While TheStreet remains skeptical of small-cap stocks, I’m in no hurry to dismiss this group completely. Goldman’s David Kostin wrote in a note to clients this week that a positive employment report could further increase investors’ appetite for risk.
“The market is likely to underestimate the probability of a significant weakening in the labor market, so strong employment may encourage some investors to move away from expensive ‘quality’ stocks to less popular lower quality stocks,” Kostin said. “There is a possibility that they will switch their investments to companies.”
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Seana Smith is an anchor at Yahoo Finance. Follow Smith on Twitter @SeanaNSmith. Have a tip about a deal, merger, activist situation, or more? Email seanasmith@yahooinc.com.
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