Riskiest stocks lose performance edge as interest rates rise

Skip to Content News Archives Economy Energy Oil & Gas Renewables Electric Vehicles Mining Commodities Agriculture Real Estate Mortgages Mortgage Rates Finance Banking Insurance Fintech Cryptocurrency Work Wealth Smart Money Wealth Management Investor Personal Finance Family Finance Retirement Taxes High Net Worth FP Comment Executive Women Puzzmo Newsletters Financial Times Business Essentials More Innovation Information Technology FP500 Podcasts Small Business Lives Told Tails Told Shopping Financial Post Store Obituaries Place a Notice Advertising Advertising With Us Advertising Solutions Postmedia Ad Manager Sponsorship Requests Classifieds Place a Classifieds ad Working Profile Settings My Subscriptions My Offers Newsletters Customer Service FAQ News Economy Energy Mining Real Estate Finance Work Wealth Investor FP Comment Executive Women Puzzmo Newsletters Financial Times Business Essentials This advertisement has not loaded yet, but your article continues below.HomeInvestorRiskiest stocks lose performance edge as interest rates riseThe Russell 2000 Index is however still on track for its best year in a decade relative to the SP 500Author of the article:Optimism over a strong pace of earnings growth in the Russell 2000 index has overshadowed concern about rising rates for most of the year. Photo by Michael Nagle/Bloomberg via Getty ImagesFor most of this year, investors have flocked into small caps to diversify away from the concentrated artificial intelligence trade. Rising interest rates are threatening to put a damper on that.THIS CONTENT IS RESERVED FOR SUBSCRIBERS ONLYSubscribe now to read the latest news in your city and across Canada.Exclusive articles from Barbara Shecter, Joe O'Connor, Gabriel Friedman, and others.Daily content from Financial Times, the world's leading global business publication.Unlimited online access to read articles from Financial Post, National Post and 15 news sites across Canada with one account.National Post ePaper, an electronic replica of the print edition to view on any device, share and comment on.Daily puzzles, including the New York Times Crossword.SUBSCRIBE TO UNLOCK MORE ARTICLESSubscribe now to read the latest news in your city and across Canada.Exclusive articles from Barbara Shecter, Joe O'Connor, Gabriel Friedman and others.Daily content from Financial Times, the world's leading global business publication.Unlimited online access to read articles from Financial Post, National Post and 15 news sites across Canada with one account.National Post ePaper, an electronic replica of the print edition to view on any device, share and comment on.Daily puzzles, including the New York Times Crossword.REGISTER / SIGN IN TO UNLOCK MORE ARTICLESCreate an account or sign in to continue with your reading experience.Access articles from across Canada with one account.Share your thoughts and join the conversation in the comments.Enjoy additional articles per month.Get email updates from your favourite authors.THIS ARTICLE IS FREE TO READ REGISTER TO UNLOCK.Create an account or sign in to continue with your reading experience.Access articles from across Canada with one accountShare your thoughts and join the conversation in the commentsEnjoy additional articles per monthGet email updates from your favourite authorsSign In or Create an AccountThe Russell 2000 index has already narrowed its lead over the S&P 500 this year from 11 percentage points in June to just two percentage points this week. Now, with the market pricing in more hikes and worries growing that the process of taming inflation will be painful, the path forward is looking fragile for small-cap companies already saddled with the reputation of being among the riskiest groups of stocks.“The largely performative hikes are neither apt to impede earnings as the driver of S&P 500 gains nor to significantly deter inflation,” Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management, said in a note to clients. At the same time, she sees “marginally cooler growth in already-weak areas, such as housing, regional bank lending and small caps.”Canada's best source for investing news, analysis and insight.By signing up you consent to receive the above newsletter from Postmedia Network Inc.A welcome email is on its way. If you don't see it, please check your junk folder.The next issue of Investor will soon be in your inbox.We encountered an issue signing you up. Please try again“The implication is that some equity market broadening is apt to fade, again giving way to a concentrated, AI/Magnificent Seven-oriented tape and a renewed sense of economic imbalance,” she added.Already, the Russell 2000 has breached its 50- and 100-day moving averages, while larger equity benchmarks continue to trade above their support levels. Despite Monday’s rally, the small-cap index remains two per cent below its 100-day average. Yet even after the recent weakness, the Russell 2000 is on track for its best year in a decade relative to the S&P 500.“We’ve been in a period where low-quality small-caps were what was working for about a year and a half, and that performance got very extended,” said Jill Carey Hall, Bank of America Corp.’s equity and quant strategist. She urged investors to “avoid more levered and rate-sensitive small caps given the Fed is hiking.”That won’t be easy. Some of the most successful, highest-quality names have been rebalanced out of the index, leaving the average stock in the group smaller and more sensitive to a rate-hiking cycle.Bloom Energy Corp., Credo Technology Group Holding, Sterling Infrastructure Inc. and TTM Technologies Inc. collectively accounted for two-thirds of the Russell 2000’s advance through June 29, when they were all moved to the Russell 1000 index.“It was a bit more concentrated than usual,” Carey Hall said of the first-half, small-cap performance. From here, she expects mid caps to outperform small caps given the recent index rebalance and rising interest rates.Moreover, multiple stocks that had been beneficiaries of the AI trade were also among those moved out of the Russell 2000, including Credo Technology Group Holding Ltd. and Fabrinet.“With both the rates backdrop and AI composition effects becoming less supportive, we continue to see downside risks for small caps,” said Barclays PLC strategist Stefano Pascale. He recommended investors hedge against the “big rate bites” for small caps with bearish Russell 2000 put spreads.This advertisement has not loaded yet.This advertisement has not loaded yet, but your article continues below.Stefano traced the narrowing performance gap between large- and small-cap stocks to the release of the FOMC meeting minutes in July, which pushed traders to re-price their interest rate expectations.To be sure, optimism over a strong pace of earnings growth in the Russell 2000 index has overshadowed concern about rising rates for most of the year. Small-cap stocks just posted their fastest quarter of earnings growth since 2022, data compiled by Jefferies show.JPMorgan Chase & Co.’s Andrew Tyler is among those preferring to stay away from small caps, at least for now. The bank’s head of global market intelligence maintains a preference for larger stocks with “small caps still pressured,” he said in a note to clients on Monday. Tyler noted that fund flows from professional money managers show more risks to the Russell 2000 than to the S&P 500 and Nasdaq 100.“Small caps have clearly lost their leadership position in the market,” said Jeff Jacobson, head of derivative strategy at 22V Research.We apologize, but this video has failed to load.Notice for the Postmedia NetworkThis website uses cookies to personalize your content (including ads), and allows us to analyze our traffic. Read more about cookies here. By continuing to use our site, you agree to our Terms of Use and Privacy Policy.