Since the beginning of July, shares of smaller US companies, tracked by the index, are up more than 10%. This is due to investors’ expectations that the US Federal Reserve will lower interest rates and predictions about the outcome of the upcoming election.
For an investment category that has generally fared worse than others for much of the past decade, the recent surge in value has led to doubt whether the rise in small-cap stocks can continue.
In a paper released Monday, Wells Fargo analysts expressed a cautious outlook, indicating that the increase in the value of stocks of small companies like these is usually short-lived.
Looking at past patterns, this cautious position is supported, with past increases in the value of small company shares often being triggered by specific events, such as the 2016 election, the initiation of new tariffs of business in 2018 and the change in the last quarter of 2023 from the concern of an increase in interest rates by the Federal Reserve to the expectation of a significant reduction.
“Each of these periods in which smaller company stocks started out better than larger company stocks for similar reasons, and the superior performance of small company stocks was not continued for a long time,” analysts at Wells Fargo. “We believe the current surge could end the same way.”
Analysts also point out that the underlying economic rationale for supporting these stocks is not strong.
They noted that the Russell 2000 Index has yet to show earnings growth, raising doubts about the longevity of the stock price rally. Expected earnings for these small companies continue to decline, and more than 40% of Russell 2000 companies are unprofitable.
Additionally, small companies typically lack the financial flexibility and ability to set higher prices that often help larger companies in the current economic climate. According to the Wells Fargo team, with the expected economic slowdown in the near future, these small companies may face more difficulties.
“We advise investors not to follow the recent improved performance of smaller US company stocks,” the report said.
“Like previous increases driven by investor sentiment, we believe the recent increase in the value of small-cap stocks is unlikely to last.”
In early August, US stocks fell sharply after economic data released on Thursday raised fears of a faster-than-expected economic slowdown even as the Federal Reserve maintained its tight monetary policy. .
The small-business-focused Russell 2000 index fell 3.03%, posting its biggest single-day percentage decline since Feb. 13. Small company stocks are subject to frequent price changes as investors move between cheaper and more expensive stocks.
“Without a strong economy, small businesses, which are most affected by economic changes, will not perform well, even if interest rates fall,” Interactive Brokers analysts said.
Stocks initially rallied, but gains were erased after data showed the Institute for Supply Management (ISM) measure of factory activity fell in July to its lowest point in eight months, at 46.8. a sign of recession.
Traditionally, August is one of the months where stocks get worse.
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