Small Caps in a Falling Rate Environment
Our industry frequently relies on broad generalizations and widely accepted phrases to guide discussions. Commonly espoused principles such as “the market dislikes uncertainty,” “higher risk correlates with higher rewards,” and “follow the trend” have become integral to our collective knowledge. In the current landscape, the idea that “falling interest rates bode well for equities” has gained prominence.
While acknowledging the inherent variability of these statements, it’s essential to recognize that they persist for a reason. They embody prevailing sentiments and capture observed tendencies, serving as shorthand for complex market dynamics. Though not universally applicable, these adages hold true often enough to become embedded into our vocabulary.
In exploring the concept that “equities thrive amid declining interest rates,” we have compiled data spanning both small and large-cap indices from the 1980s onwards. Our objective was to scrutinize index behavior following the Federal Reserve’s initial decisions to lower interest rates. The subsequent analysis, presented below, affirms the credibility of the adage, uncovering consistently positive trends across each index during the 3-, 6-, and 12-month periods subsequent to an initial rate cut. Furthermore, our findings emphasize that growth, particularly in the small-cap segment, emerges as the clear frontrunner across each of these time frames.
The prospect and increasing likelihood of the Federal Reserve lowering interest rates in the near future have, historically, been associated with favorable outcomes for equities. Notably, this trend serves as an influential tailwind, particularly benefiting the small-cap growth segment of the market. Furthermore, consider this variable in conjunction with nearly four years of notably reduced valuations in comparison to their larger counterparts. In the event of an interest rate catalyst propelling equities to new peaks, small caps could benefit from an extended runway for appreciation. These current valuations play a crucial role in shaping potential performance in contrast to preceding periods of interest rate cuts.
At Hood River, we’ve honed a proprietary analysis process for over two decades. Our method revolves around seeking to identify potential information gaps between our earnings estimates and Wall Street projections. The team diligently collaborates with management, customers, suppliers, and competitors to construct and validate our estimates. This strategic approach enables us to stay intimately connected to the earnings pulse of the small and small/mid-cap markets. Consequently, our portfolio remains agile, consistently adjusting to the areas where we anticipate growth to be most pronounced.
We look forward to discussing the current environment and the status of our portfolio as we progress through 2024. Feel free to reach out at any time for a conversation; we welcome the opportunity to connect with you.
All investing includes risk, including the loss of principal. Information has been gathered from sources considered to be reliable, however its accuracy cannot be guaranteed. Investors in Hood River’s strategies acknowledge and agree that (i) any information provided by the Firm is not a recommendation to invest in any of the strategies offered by the Firm and that the Firm is not undertaking to provide any investment advice to the investor (impartial or otherwise), or to give advice to the investor in a fiduciary capacity in connection with an investment in the strategy and, accordingly, no part of any compensation received by the Firm is for the provision of investment advice to the investor and (ii) Hood River has a financial interest in the investor’s investment in the strategies offered by the Firm on account of the fees and other compensation the Firm expects to receive from the client. The Russell 2000® Growth Index measures the performance of those Russell 2000® companies with higher price-to-book ratios and higher forecasted growth values. The Russell 2000® Value Index measures the performance of those Russell 2000® companies with lower price-to-book values and lower forecasted growth values. The Russell 1000® Growth Index measures the performance of those Russell 1000® companies with higher price-to-book ratios and higher forecasted growth values. The Russell 1000® Value Index measures the performance of those Russell 1000® companies with lower price-to-book values and lower forecasted growth values. Investors cannot invest in an index. Past performance is no guarantee of future results. Not FDIC insured, no bank guarantee, may lose value.
