Rising Rates in Focus as Small Caps Retreat Below 200-Day Average

“Despite higher interest rates typically being good for small-caps, leverage is very elevated and some investors may worry that (high-yield bond) spreads widen, which could raise the cost of funding for smaller companies,” said Bryan Reilly, a managing director at CIBC Private Wealth Management.

This, however, doesn’t mean investors should shy away from adding small caps into their portfolios or add ETFs that focus on the small cap space, such as the iShares Russell 2000 ETF (NYSEArca: IWM). Leuthold Group Chief Investment Strategist Jim Paulsen noted that historically, large caps and small caps eventually revert back to the mean and when one lags, the other eventually catches up.

“One thing that would work as a result that I would argue from this is that if large (caps) have done well for a while, buy small,” Paulsen told Barron’s. “If small has been good for a while buy large. And that’s been a really good approach for the last 15 years.”

“Because of how long this cycle has gone, and with rates going up, people are becoming more risk-averse,” said Paulsen. “So people move to the popular, performing names, and feel good in those, which in part reflects some of their anxiety.”

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