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Small caps are finally getting a bit of a moment, hot commodities amid the recent stock rotation.
Money has poured into the Russell 2000 Index of small-cap equities, still up by around 8% after pulling back from a whopping 12% surge over a five-session period, as my colleague Jared Blikre wrote. That’s in part because smaller companies are seen as benefiting disproportionately from the beginning of the Federal Reserve’s rate-cutting cycle.
The iShares Russell 2000 ETF (IWM) has been a big winner, gaining $7.1 million in inflows over the week ended Wednesday, according to Bloomberg data. That compares with about $2.7 million for the Invesco QQQ Trust (QQQ), which tracks the Nasdaq 100. It’s also a sharp reversal from the trends thus far in 2024, with the IWM seeing outflows of $1.1 billion.
But not everyone’s buying into the idea that the rally will continue — or if it does, that buying the whole index is the right way to play it.
Eric Johnston, chief equity and macro strategist at Cantor Fitzgerald, is one of the skeptics.
As he laid out in a recent note to clients, small-cap earnings are forecast to be unchanged versus 2021; valuations are high, and so is short interest, implying that some of the recent move is a short squeeze that makes it less sustainable.
The squeezy aspect of the rally was also highlighted by Ed Yardeni of Yardeni Research in an interview with Yahoo Finance: “You'll see that the big moves have been in biotech and also in banking, regional banks, small regional banks, and a lot of that could just be simply short covering. I don't know that their fundamentals have radically changed, so I'd be a little wary of chasing the mid-caps, the Russell 2000,” he said.
Even those who are buying small caps aren’t necessarily buying all of them. Among that cohort is Savita Subramanian, head of US equity & quantitative strategy at Bank of America Securities. In a midyear outlook call, she pointed out that roughly one-third of Russell 2000 constituents are unprofitable, so her picks are more targeted.
“The areas within the small-cap spectrum that look more attractive are the higher-quality cohorts,” she said. “So within small caps, industrials, even energy companies, areas that have kind of potentially more GDP sensitivity, more consumption sensitivity would look more attractive, whereas the areas that have more refinancing risk, or more credit sensitivity, are potentially still in the penalty box until the Fed actually begins to cut rates."
Indeed, in Wednesday and Thursday’s sessions, the broad small-cap trade lost steam. But judging from the many other small-cap inflows outside of the IWM ETF, there’s still plenty of optimism out there.
Julie Hyman is the co-anchor of Yahoo Finance Live, weekdays 9 a.m.-11 a.m. ET. Follow her on Twitter @juleshyman, and read her other stories.
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