Is a rebound on the way? The Russell 2000 Index, one of the most widely followed gauges of small-cap stocks, is higher by 2.82% year-to-date, but that’s still well above the pace set by the S&P 500, which is up 9.26%.
That confirms the small-cap/large-cap chasm remains wide, frustrating investors who turn to the former for growth opportunities. Still, it’s important to note that smaller stocks, in the aggregate, aren’t delivering “bad” performances, which could signal opportunity with exchange traded funds such as the Invesco NASDAQ Future Gen 200 ETF (QQQS).
Year-to-date, QQQS has generated a modest upside, but there is runway for more if some overhangs afflicting small-cap equities dissipate.
Keys to a Small-Cap Rebound
Entering 2024, many market observers believed small-cap stocks were ripe for upside on the basis that the Federal Reserve would lower interest rates several times this year. That’s a credible catalyst for QQQS, home to a bevy of rate-sensitive biotechnology and technology stocks.
Now, it appears the central bank will be more measured in its approach to cutting borrow costs, but that doesn’t spell the end of potential catalysts for smaller stocks and ETFs such as QQQS. To some extent, small caps have been hamstrung by investors’ enthusiasm for artificial intelligence (AI), which has been largely tapped via large-cap equities. That is to say, if market breadth widens, QQQS could benefit, but it also offers insurance in the form of a 30% allocation to tech stocks.
“By some measures, small company stocks have been due for a breakout for a very long time. They’re cheap, they’ve underperformed for years, and a healthy economy means they have plenty of room to grow,” noted Morningstar analyst Sarah Hansen.
The Need To Borrow
The interest rate scenario will likely continue prominently in the small-cap equation because many of these companies, including some in the QQQS portfolio, need to borrow capital to fund research and development, incurring higher financing costs.
“Investors often look to small caps for their growth potential, but that potential comes with a downside. Because they’re less likely to be profitable and more likely to need to borrow money to fund their operations, small-cap companies are much more sensitive to changes in interest rates than larger stocks,” adds Hansen.
On the other hand, assets such as QQQS could potentially deliver gains even if the Fed doesn’t cut rates, assuming the U.S. economy remains sturdy. For now, a recession appears unlikely, which is noteworthy to investors considering a domestic-heavy asset class like small-caps.
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