Major indexes (^DJI, ^IXIC, ^GSPC) are trading mixed as markets rebound from a tech sell-off. However, small-cap stocks have shown some strength in recent days. Savita Subramanian, BofA Securities Head of U.S. equity strategy & U.S. quantitative strategy, joins Market Domination to discuss the small-cap trend.
Subramanian calls small caps “tricky.” She notes the Russell 2000 (^RUT) is “cheap and looks like it could do well,” but there’s a problem: many companies in the index aren’t likely to grow. She explains many small-cap companies in the index are “former large-cap companies that drifted into the Russell [2000] over the last couple of years because they can’t hack higher interest rates.”
With the Federal Reserve keeping rates high, Subramanian advises caution: “It’s almost like you need to see that first rate cut in order to buy that entire index wholesale because there are a lot of companies in the smaller cap benchmark that have floating rate risk, [and] that have refinancing risk.” She adds: “Over a third of the Russell 2000 growth benchmark just doesn’t make any money.”
For more expert insight and the latest market action, click here to watch this full episode of Market Domination.
This post was written by Angel Smith
Video transcript
Small caps.
They’re, they’re in the green and, and outperforming again today, Savita your thoughts there?
Yeah, small caps is tricky and I, I think that, you know, the Russell 2000 looks cheap.
It looks like it could do well in a, you know, in a, in a more domestically driven economic cycle.
Like what I’m alluding to the problem is the Russell is not just, you know, kind of the small domestic plays and the, you know, the nascent growth stocks that are about to grow up into big cap companies, small caps have really changed to a much, uh, kind of a, a trickier benchmark.
So the problem is that a lot of small companies are former, old, uh, former large cap companies that drifted into the Russell over the last couple of years because they can’t hack higher interest rates.
So our view here is ok.
Unless we start to see the, that really tell us short rates are at peak levels, we are going to cut.
In fact, we are cutting interest rates.
I think it’s almost like you need to see that first rate cut in order to buy that entire index wholesale because there are a lot of companies in the smaller cap benchmark that have floating rate risk that have refinancing risk.
Um Commercial real estate is much more prevalent in the small benchmark than the large benchmark.
Regional banks are still working out a lot of their lending that they’ve done over the last 10 years, assuming much lower interest rates than what we’re experiencing today.
So those are areas that I would worry about.
Um I think that there are big pockets of the small cap benchmark that look attractive but not the broader index overall.
And the problem again, I’ll cite a statistic for you that makes me a little bit nervous.
Um, you know, um over a third of the Russell 2000 growth benchmark just doesn’t make any money and that is a record high.
And I think that is the problem is that a lot of these companies are really just, you know, companies that survived in a zero interest rate environment, but aren’t gonna hack it in a 5% or even 3% interest rate environment if that’s the run rate from here.
