The higher-for-longer interest rates narrative could continue to negatively affect small-cap companies. This is because they look to stay afloat in the current macroeconomic environment.
Heading into 2023, there was much optimism for small-caps and all equities in general. This is because capital markets expected high rates to eventually dissipate. However, stubborn inflation is putting many small companies in a bind. This is because the Federal Reserve keeps monetary policy tight. That makes it more expensive to borrow money amid rate hikes.
Larger-cap companies often have the reserve capital to withstand the high borrowing costs. The same can’t be said for small-caps. While the S&P 500 is up about 11% for the year despite the recent pullback, the Russell 2000 recently went into negative territory as rising rates continue to rack these companies.
A drop in the Russell 2000 could also be more indicative of the broader economy compared to their larger-cap brethren. The higher-for-longer narrative could continue to strain these companies financially until the Fed decides to loosen monetary policy. Nobody knows when that might occur.
“The Russell 2000′s comparative weakness relative to the broad market indexes underscores Wall Street’s concerns that the 2023 market rally has been too narrow,” a CNBC article said. “By contrast, the Russell 2000 is often perceived as a better insight into the state of the broader U.S. economy due to its focus on smaller businesses whose fate depends more on macroeconomic conditions.”
Play Small-Cap Weakness
As the Russell 2000 turns negative, that creates an opportunity for the bears. More specifically, they can play the weakness tactically via the Direxion Daily Small Cap Bear 3X Shares (TZA), which seeks daily investment results equal to 300% of the inverse (or opposite) of the daily performance of the aforementioned Russell 2000 Index.
As mentioned, large-cap companies have been at the forefront of 2023’s market rally, especially big tech. However, they’ve simply left small-caps in the dust as 2023 comes to a close. That is, unless the macroeconomic environment improves, namely regarding lower interest rates.
“Mega-cap tech titans have been reaping economic rewards of 2023 while leaving most of the rest of the market behind,” an Investor Place article said. “While a few growth firms see their shares continue to rally, several companies are struggling to tread water as the economy weakens amid inflation and rising interest rates.”
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