Small-Cap Stocks Poised for a Comeback
After years of underperformance, small-cap stocks are finally getting their moment in the sun. Since the election, the Russell 2000 has outpaced its larger counterpart, the S&P 500, and experts believe this trend is set to continue.
The Impact of Interest Rates
One major factor contributing to small-cap stocks’ recent success is the surge in US interest rates. According to Steve Sosnick, chief strategist at Interactive Brokers, higher interest rates have historically hindered small-cap performance. Many small-cap companies rely on borrowed money to stay afloat, making them more vulnerable to rate hikes. However, with interest rates on the rise, small-cap investors may finally see a turnaround.
Seasonality: A Historical Advantage
Jeff Hirsch, editor in chief of the Stock Trader’s Almanac, points out that small-cap stocks tend to excel during the year-end rally, typically from mid-December to mid-March. This phenomenon, known as the “January effect,” has been observed for decades and could work in favor of small-cap investors.
Policy Changes and Their Impact
The incoming Trump administration’s policies are also expected to shape the fortunes of small-cap stocks. Tariffs and stricter immigration policies may increase the cost of goods and services, putting pressure on small-cap companies’ margins and profitability. On the other hand, deregulation and potential changes in Cabinet leadership could benefit smaller companies.
The Strong Dollar: A Headwind for Small Caps
A strong US dollar, driven by surging Treasury yields and Trump’s policies, poses a significant threat to small-cap stocks. A rapid dollar rise can lead to supply chain disruptions, reduced demand, and increased debt servicing costs, ultimately impacting small-cap performance.
A Correction on the Horizon?
Real Vision CEO Raoul Pal warns that the recent strength in the dollar and interest rates may lead to a market correction towards the end of the year or early next year. As markets are forward-looking, investors should be prepared for potential turbulence ahead.
The Bottom Line
Despite the challenges, small-cap stocks are poised for a comeback. With interest rates on the rise and seasonality working in their favor, investors may want to consider adding small-cap stocks to their portfolios. However, they should also be aware of the potential headwinds, including the strong dollar and policy changes, and adjust their strategies accordingly.
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