Not everyone is joining the rally.
The stock market has rallied in the last week and a half, but small market cap stocks have underperformed. The point is that interest rates will remain high for at least the next several months – a problem for the entire equity market.
First, a little context. The S&P 500 is up 0.8% since hitting the bottom on Aug. 17. The mild relief rally of the index has continued, with Federal Reserve Chairman Jerome Powell’s Friday speech at the Jackson Hole Economic Symposium not explicitly mentioning further interest rate hikes, which would be aimed at reducing demand and inflation. Help
The 10-year Treasury yield, currently hovering around 4.2%, also remains below its multi-year high of just over 4.3% in early August. The stabilization of yields is good news for the stock market, which is expecting the still-growing US economy to remain resilient.
However, less optimistic market watchers may point to the relatively poor performance of smaller market capitalization stocks.
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The S&P 600 index, which is comprised of companies with smaller market caps, has been roughly flat since August 17 — but if the market is overly optimistic about growth, it will outperform. Improvements in economic growth tend to increase earnings of smaller companies more than larger ones. This is because smaller firms often have higher interest expense and other fixed costs, so when sales increase, profits increase more quickly.
However, interest rates are likely to remain high for some time, which should hamper economic and profit growth. Although his speech was vague, Powell said that monetary policy needed to remain restrictive for some time to reduce inflation – code for the fact that the Fed would likely keep interest rates high for some time.
The takeaway, however, is that higher rates with a delay hurt the economy. The fact that the US economy maintained growth above 2% in the first quarter of this year – almost unchanged through the fourth quarter of 2022 – could mean that growth can only slow from here.
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Tom Esse of the Sevens Report says, “I expect the economy to slow down in the coming weeks.” “The longer rates are still at these levels, the longer it will restrain growth.”
The point is that one should not get too excited about the recent rally in the stock market. Small-caps serve as a leading indicator.
Write to Jacob Sonenshine at [email protected]
Source: www.barrons.com
