Dow Jones drops 500 points, Nasdaq falls as tech stocks continue slide

One of Wall Street’s favorite calls to start 2024 has finally joined the stock market rally.

After significantly underperforming the broader market during the first six months of the year, small-cap stocks rallied last week after a better-than-expected June inflation reading made markets increasingly optimistic about interest rate cuts by the Federal Reserve.

Last month, the Russell 2000 index of small companies gained about 10%, far outpacing the S&P 500’s 1.4% gain in the same time frame. The burning question among Wall Street strategists now is whether the rally has much more room to run.

“We believe there is scope for a continued downward pivot if interest rates remain reasonable and the Trump 2.0 trade continues ahead of the US election,” Maxwell Grynakov, U.S. derivatives strategist at UBS Investment Bank, wrote in a note to clients on Thursday.

Keys to a continued rally include further slowdown in inflation and economic data showing similar or higher levels of growth, Grinkov added.

On Wednesday, Savita Subramanian, head of U.S. equity and quantitative strategy at Bank of America, told Yahoo Finance that this trend in small-cap companies “is likely to continue.” But for Subramanian, that doesn’t mean simply buying the Russell 2000 is the right trade.

Subramanian said about a third of the Russell 2000 funds are not profitable, and overall the index faces much greater refinancing risk amid higher interest rates than an index like the S&P 500.

“If we are in fact at a point where short interest rates are peaking and we are likely to see cuts, as that certainty improves, smaller caps are likely to start outperforming their competitors,” Subramanian said. “In fact, their valuations are at levels that would warrant a pretty fair comeback. I think the areas within the small cap spectrum that look most attractive are the higher quality categories. So within the small cap, industrials, even energy companies, areas that may be more sensitive to GDP, more sensitive to consumption, will look most attractive.”

“Areas with higher refinancing risks, or greater credit sensitivity, may remain in the penalty box until the Fed actually starts cutting rates,” she added.