Waiting on small-cap stocks and related ETFs to rally in earnest has, for many market participants, become an exercise in futility. Some encouraging news for smaller equities may have arrived last week in the form of the May reading of the Consumer Price Index (CPI).
The report released Wednesday was better than expected and showed signs of cooling across a variety of marquee categories. That report sparked one-day gains for a plethora of small-cap ETFs, including the Invesco NASDAQ Future Gen 200 ETF (QQQS). One day isn’t meaningful in the broader outlook for small-caps. But the inflation report could be an indication that the macroeconomic stars are finally aligning for smaller stocks and the ETFs that hold those shares.
Cooling inflation could be a credible catalyst for small-caps. That includes QQQS components, for a variety of reasons. For example, stability on the inflation front could bring comfort to consumers and potentially boost discretionary spending. That could benefit the broader economy. Small-caps are historically more economically sensitive than large-cap counterparts.
Then There’s Interest Rates
Perhaps even more important than the above scenario as it pertains to QQQS and other small-cap ETFs is the point that cooling inflation could set the stage for the Federal Reserve to cut interest rates twice before the end of this year. That’s relevant because “higher for longer” has been a headwind for small-cap stocks.
“The higher-for-longer interest-rate environment hasn’t helped small-caps so far in 2024. Early this year, many investors had banked on five or six interest-rate cuts in 2024 from the Federal Reserve, a development that could have helped boost consumer spending and juiced the sales and earnings growth of smaller U.S. companies. Now we’ll be lucky if we get one or two rate cuts. But that might be enough to get small-caps out of the doldrums,” reported Paul La Monica for Barron’s.
Further catalysts for QQQS could arrive by way of lower interest rates helping small-cap financial stocks. That’s because those shares have been drags on small-cap value strategies. QQQS allocates 35% of its roster to value stocks. But it has no exposure to the financial services sector, indicating the ETF has been unduly punished.
Additionally, EY recently noted that large-cap pharma companies are sitting on $1 trillion in cash, some of which could be deployed for acquisitions in the biotech space. That’s pertinent to investors considering QQQS because the ETF allocates nearly 51% of its weight to healthcare stocks, some of which are credible biotech takeover targets.
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