It looks like small caps were the winning trade following the Federal Reserve’s supersized rate cut on Wednesday . In the first full trading session since the central bank’s move, the iShares Russell 2000 ETF (IWM) that tracks stocks with small market values climbed about 2%. With that, the fund has climbed 3.1% this week and 10.2% in the third quarter alone, double the return of the S & P 500 in each period. But Wall Street is already doubting whether the small cap run will continue. IWM 1D mountain IWM, 1-day The conventional wisdom is that rate cuts disproportionately benefit small caps because smaller companies are more likely to use floating rate borrowing — the cost of which is likely to decline — and are more leveraged to changes in the economy than large-cap companies. Yet, historical data shows that more often than not, large companies have actually won out over small-cap stocks in a landscape of lower rates. Going back to 1980, small caps have trailed large caps by an average of 1.38 percentage points, or 138 basis points, in the 65 days after the Fed first started cutting rates, according to research firm Strategas Securities. Large-cap stocks easily outperformed small caps in five of eight instances when the Fed was lowering rates, small caps outperformed twice and in one case, 1995, there was virtually no difference. The only time when neither the S & P 500 nor the Russell 2000 easily beat out the other was during the Federal Reserve’s successful soft landing of the economy during the first Clinton term. In that case, the small-cap index topped the broad market index by just 0.1%, and Strategas notes that accelerating GDP growth was the likely contributor. The immediate obstacle burden for small caps comes from seasonal factors, with Bank of America analysts warning that September and October historically have been weak for the stocks. “We expect continued volatility ahead of the U.S. election (where small caps are negatively correlated with changes in the VIX),” the BofA analysts wrote in a note to clients. “Uncertainty over macro data (e.g. continued weakness in manufacturing, heightened focus on the jobs data) plus the recent shift in our U.S. Regime Indicator to ‘Downturn’ all support our preference for large vs small [stocks],” the analysts wrote. In Thursday’s session, the S & P jumped 1.7% to a fresh all-time high, topping the 5,700 mark for the first time. This week, the index is up more than 1%.
