izusek
Morgan Stanley’s U.S. equity strategists recommended investors consider exposure to small-cap growth stocks, with likely rate cuts by the Federal Reserve standing on deck.
The strategists’ “nuanced relative call” within small-caps (RTY) puts a preference on long growth over value stocks, Katy Huberty, global director of research at Morgan Stanley, said in a note Tuesday. The Russell 2000 small-caps index (RTY)(IWM) on Tuesday logged its fifth straight win and Treasury yields (US10Y)(US2Y) continued their downward trend, supported by strengthened bets that rate cuts will start this year.
“Longer-duration Small Caps that are growth-oriented and more sensitive to changes in their cost of capital have benefitted on a relative basis as yields have come down, while the Small Caps that are more economically sensitive (i.e., Value) have not benefitted,” Huberty said about the MS call.
The small-caps growth trade holds more relative upside stemming from earnings revisions, according to the MS strategists. Huberty also said history shows that the small-cap growth cohort typically outperforms when the Fed begins cutting rates. Biotech stocks are potential winners as that industry has the largest weight in the Russell 2000 small-cap index (RTY). Biotech “has a strong relative performance track record post the start of Fed rate cuts,” she said.
A rotation by investors into small-caps out of mega-cap tech stocks that dominate the S&P 500 (SP500)(SPY) started last week after June consumer-price inflation data showed further cooling toward the Fed’s 2% target. Traders are now pricing in the potential for at least two rate cuts, reawakening a market theme from earlier this year centered on the Fed enacting multiple rate reductions.
The Russell 2000 (RTY) rose 3.6% on Tuesday, bringing its YTD gain to +11%. The Russell 2000 Value Index is up 8.6%, and the Russell 2000 Growth Index has gained 14.9% this year. The S&P 500 (SP500)(SPY) has shot up nearly 19% in 2024.
Small-Cap ETFs include (IJR), (VBR), (SPSM), and (DFAS).
