S&P 500   5,137.08
DOW   39,087.38
QQQ   445.61
Lawyers who successfully argued Musk pay package was illegal seek $5.6 billion in Tesla stock
Critical asset just had biggest fall on record (Ad)
Sports analytics may be outnumbered when it comes to artificial intelligence
In Senegal's capital, Nicaragua is a hot ticket among travel agents as migrants try to reach US
Critical asset just had biggest fall on record (Ad)
Norway's hospitalized king gets a pacemaker in Malaysia after falling ill during vacation
Head Start preschools aim to fight poverty, but their teachers struggle to make ends meet
This is the #1 Stock to Buy for the AI Tidal Wave (Ad)
What to watch for as China's major political meeting of the year gets underway
Chicago 'mansion' tax to fund homeless services stuck in legal limbo while on the ballot
S&P 500   5,137.08
DOW   39,087.38
QQQ   445.61
Lawyers who successfully argued Musk pay package was illegal seek $5.6 billion in Tesla stock
Critical asset just had biggest fall on record (Ad)
Sports analytics may be outnumbered when it comes to artificial intelligence
In Senegal's capital, Nicaragua is a hot ticket among travel agents as migrants try to reach US
Critical asset just had biggest fall on record (Ad)
Norway's hospitalized king gets a pacemaker in Malaysia after falling ill during vacation
Head Start preschools aim to fight poverty, but their teachers struggle to make ends meet
This is the #1 Stock to Buy for the AI Tidal Wave (Ad)
What to watch for as China's major political meeting of the year gets underway
Chicago 'mansion' tax to fund homeless services stuck in legal limbo while on the ballot
S&P 500   5,137.08
DOW   39,087.38
QQQ   445.61
Lawyers who successfully argued Musk pay package was illegal seek $5.6 billion in Tesla stock
Critical asset just had biggest fall on record (Ad)
Sports analytics may be outnumbered when it comes to artificial intelligence
In Senegal's capital, Nicaragua is a hot ticket among travel agents as migrants try to reach US
Critical asset just had biggest fall on record (Ad)
Norway's hospitalized king gets a pacemaker in Malaysia after falling ill during vacation
Head Start preschools aim to fight poverty, but their teachers struggle to make ends meet
This is the #1 Stock to Buy for the AI Tidal Wave (Ad)
What to watch for as China's major political meeting of the year gets underway
Chicago 'mansion' tax to fund homeless services stuck in legal limbo while on the ballot
S&P 500   5,137.08
DOW   39,087.38
QQQ   445.61
Lawyers who successfully argued Musk pay package was illegal seek $5.6 billion in Tesla stock
Critical asset just had biggest fall on record (Ad)
Sports analytics may be outnumbered when it comes to artificial intelligence
In Senegal's capital, Nicaragua is a hot ticket among travel agents as migrants try to reach US
Critical asset just had biggest fall on record (Ad)
Norway's hospitalized king gets a pacemaker in Malaysia after falling ill during vacation
Head Start preschools aim to fight poverty, but their teachers struggle to make ends meet
This is the #1 Stock to Buy for the AI Tidal Wave (Ad)
What to watch for as China's major political meeting of the year gets underway
Chicago 'mansion' tax to fund homeless services stuck in legal limbo while on the ballot

Will Fed Rate-Hike Pause Lead To Small-Cap Outperformance?

Federal reserve rate hike

Key Points

  • A Bank of America research note suggests that quality small caps tend to outperform after the last rate increase in a series.
  • CME Group research found small and mid-cap stocks historically outperform large caps during periods of economic turbulence.
  • Small and mid-cap stocks underperformed in March due to regional banking turmoil.; quality small caps with recent strong price action don't come from the financials sector.
  • Diversifying with small caps offers unique growth opportunities not found in larger, established companies.
  • 5 stocks we like better than iShares Russell 2000 ETF

Domestic small caps, as tracked by the iShares Russell 2000 ETF NYSEARCA: IWM have significantly underperformed larger stocks in the past three months. You can easily compare performance of that ETF versus the large-cap SPDR S&P 500 ETF Trust NYSEARCA: SPY.

The former is down 4.80% year-to-date, while the latter has gained 5.49% during that time.

Could that situation change when the Federal Reserve hits the brakes on rate increases? 

According to a May 16 Bank of America research note, since 1989, after the last rate increase in a series, quality small cap performed the best in the following months. Bank of America categorizes a stock as “quality” by using factors such as return on equity, free cash flow, return on capital, and stocks with a positive forward price-to-earnings ratio. These are indicators of a company's financial strength and the efficiency with which it utilizes resources. 

Value Beats Growth

Bank of America also found that small-cap value outperformed small growth in those scenarios. Technical factors, such as a high one-month change in a stock’s 200-day moving average, also played a role in determining leadership. 

Is some asset-class rotation in the cards if and when the Fed pauses rate increases? 

According to research from derivatives marketplace CME Group, “Are S&P 600 & Russell 2000 Small Caps Due for a Rebound?”, small and mid-cap stocks underperformed sharply in March due to regional banking turmoil. 

CME also notes that small and mid-cap stocks historically outperform large during periods of economic turbulence, such as inflation, volatile interest rates, recession and early-stage recoveries.

While the broad financial sector struggled, the tech-lade Nasdaq 100, as tracked by the Invesco QQQ NASDAQ: QQQ, advanced 9.32% in March and built on those gains in April and May. 


Returning to the idea of quality small caps, it’s worth noting that among the group of top earners that also boast strong recent price action, none hail from the financials sector. 

These leaders include: 

Not exactly a batch of household names, but that’s exactly the point. Relying on familiar names can be a good strategy, particularly when turning to well-established defensive companies with a long history of increasing dividends

Unique Growth Opportunities

But diversifying with small caps is also important because these stocks offer unique growth opportunities that you may not find in larger, more established companies. Small stocks can, at times, return more than larger stocks.

They also have different risk and return characteristics compared to large caps, making them valuable for diversification purposes. Various types of asset classes respond differently to economic conditions or market inefficiencies. 

A perfect example of the latter situation is small stocks’ underperformance during the regional banking crisis. While large-cap techs rallied, the info tech sector only constitutes 12.36% of the small-cap Russell 2000 index. That means small caps were more sensitive to damage in the financial sector, which comprises 16.08% of the smaller index. 

Seek Higher Quality

One takeaway from Bank of America’s research is that higher quality, profitable small caps that generate strong free cash flow are typically among leaders once Fed rate hikes pause. 

This is a good reason to include broad diversification among your holdings. Investors who focused on large-cap growth stocks were rewarded handsomely in 2020 and 2021. But as investors saw in 2022, there’s bound to be sector and asset-class rotation at some point. 

An event like a pause in the Fed rate increases could be a catalyst for small-cap outperformance, but as Bank of America notes, even that could be limited to a select group of stocks.

→ Critical asset just had biggest fall on record (From Stansberry Research) (Ad)

Should you invest $1,000 in iShares Russell 2000 ETF right now?

Before you consider iShares Russell 2000 ETF, you'll want to hear this.

MarketBeat keeps track of Wall Street's top-rated and best performing research analysts and the stocks they recommend to their clients on a daily basis. MarketBeat has identified the five stocks that top analysts are quietly whispering to their clients to buy now before the broader market catches on... and iShares Russell 2000 ETF wasn't on the list.

While iShares Russell 2000 ETF currently has a "hold" rating among analysts, top-rated analysts believe these five stocks are better buys.

View The Five Stocks Here

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Companies Mentioned in This Article

CompanyMarketRank™Current PricePrice ChangeDividend YieldP/E RatioConsensus RatingConsensus Price Target
iShares Russell 2000 ETF (IWM)N/A$205.89+1.1%1.31%N/AN/AN/A
Invesco QQQ (QQQ)N/A$445.61+1.5%0.52%N/AN/AN/A
SPDR S&P 500 ETF Trust (SPY)N/A$512.85+0.9%1.29%N/AN/AN/A
Genie Energy (GNE)
1.0051 of 5 stars
$18.36+0.7%1.63%8.16N/A
M/I Homes (MHO)
1.2564 of 5 stars
$131.18+3.3%N/A8.08Hold$116.00
North American Construction Group (NOA)
4.0417 of 5 stars
$25.35+1.3%1.14%14.49Hold$39.00
NVE (NVEC)
1.5549 of 5 stars
$86.78+3.8%4.61%19.46N/A
Tecnoglass (TGLS)
1.0452 of 5 stars
$44.80-4.2%0.80%11.64Buy$49.25
Green Brick Partners (GRBK)
2.093 of 5 stars
$54.61-6.6%N/A8.89Hold$45.00
Crawford & Company (CRD)
0 of 5 stars
$0.00-100.0%N/AN/AN/A
PROG (PRG)
4.3825 of 5 stars
$31.40+1.7%N/A10.61Moderate Buy$40.25
Dream Finders Homes (DFH)
1.2628 of 5 stars
$38.54-1.5%N/A13.52Hold$23.00
NVE (NVEC)
1.5549 of 5 stars
$86.78+3.8%4.61%19.46N/A
Sterling Infrastructure (STRL)
1.2418 of 5 stars
$110.98+4.1%N/A24.94Hold$115.00
Compare These Stocks  Add These Stocks to My Watchlist 

Kate Stalter

About Kate Stalter

  • stalterkate@gmail.com

Contributing Author

Retirement, Asset Allocation, and Tax Strategies

Experience

Kate Stalter has been a contributing writer for MarketBeat since 2021.

Additional Experience

Series 65-licensed investment advisor, financial advisor, Blue Marlin Advisors; investment columnist for Forbes, U.S. News & World Report

Areas of Expertise

Asset allocation, technical and fundamental analysis, retirement strategies, income generation, risk management, sector and industry analysis

Education

Bachelor of Arts, Saint Mary’s College, Notre Dame, Indiana; Master of Business Adminstration, Kellogg School of Management at Northwestern University

Past Experience

Founder, financial advisor for Better Money Decisions; editor, stock trading instructor for Investor’s Business Daily; columnist, podcast host, video host for MoneyShow.com; contributor for Morningstar magazine


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