Small Cap Stocks Struggle Amid Shift in Interest Rate Expectations
The second quarter saw a decline in small cap US equities, as changing interest rate expectations weighed heavily on investor sentiment. Initially, markets fell as the prospect of US rate cuts was pushed out, but optimism grew throughout the quarter as encouraging inflation data revived hopes of a monetary easing cycle this year. Mixed economic data added to the uncertainty, with robust job growth offset by slower consumer spending and below-expectation GDP.
The conclusion of the first-quarter earnings season painted a mixed picture for small cap companies, which are more susceptible to domestic economic fluctuations and interest rate headwinds. Despite 60% of Russell 2000 Index companies beating consensus estimates, the index fell 3.3% in the quarter, trimming its year-to-date gain to 1.7%.
Notable stock performances included StepStone, an alternative asset manager that reported strong quarterly results driven by higher fee-earning assets under management and disciplined cost control. Onto Innovation, a semiconductor equipment maker, also exceeded expectations due to strong demand for its products amid accelerated investment in artificial intelligence. Conversely, Inspire Medical, a sleep apnea treatment maker, reported lower quarterly revenues in the US, while Japanese restaurant operator Kura Sushi reported weaker results and guidance due to softness in California.
Despite the challenges, we believe small caps are well-positioned to outperform as economic resilience, subdued inflation, lower interest rates, and a cyclical upturn provide a tailwind for the asset class. Small caps trade at a nearly two-standard-deviation discount to large caps, despite significantly higher top- and bottom-line growth forecasts. Our strategy, focused on the relationship between financial productivity and valuation, is poised to benefit from a broader and more normalized market and economic environment, positioning us favorably to generate alpha over the long term.
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