While the S&P SmallCap 600 index did jump immediately after the Fed moved on September 18th to lower interest rates, small-caps subsequently settled over the rest of the month to a level just above their pre-rate-cut close.

According to traditional wisdom, this rate cut should have been the long-awaited boon to small-cap stock performance. But then again, the stock market is seldom known for its rational responses, especially regarding near-term factors.

The lack of attention to small company stocks is certainly confounding, especially after such a long  spell of market disinterest in the stocks we cover in the SmallCap Informer.

But don’t lose hope. The bull case for small-caps remains quite firm. Here are some of the common arguments as to why small company stocks should be on the rise.

Small companies on the whole are certainly impacted by high interest rates since their debt is financed at higher and more variable rates than for larger companies. Though many of the companies covered in the SmallCap Informer are very well-capitalized and debt-free, the market tends to lump small-caps together, so most of the stocks on our coverage list should expected to be buoyed by rate cuts.

Historically, small-caps outperform large- and mid-caps following the first rate cut in a cycle. Since 1950, this effect has been seen in the three, six, and 12 months following cuts.

Small-caps are currently cheap relative to large-caps, with the trailing P/E ratio of the S&P SmallCap 600 just over half of the S&P 500’s multiple.

Small-caps historically outperform large-caps during economic expansions. With a consensus coming into place that made the economy is sound (or at least sound enough), small-caps should be given more attention.

Is all of this enough to help small-caps break out of their ten-year stretch of underperformance compared to large-cap? Considering the various curveballs thrown at the market and economy since 2014, there could be obstacles remaining. In the last ten years, U.S. businesses have had to endure many unusual conditions, such as the pandemic, near-zero interest rates, the availability of easy money, and an overhanging threat of recession.

This confluence of uncertainty may be the cause of much of the market’s reduced temperament for small company stock investing, and may be enough to keep small-caps on the sidelines for just a bit longer.

Further, many stock market bears remain convinced that the economy is not yet in tip-top shape, and mega-cap performance as illustrated by the returns of the Magnificent 7 still point to an investor preference for  companies of size over those selling at reasonable prices.

At the end of the day, fundamentals always win out (eventually) over market sentiment. Investing in high quality stocks with a long-term horizon remains an optimal way for individual investors to earn attractive returns in the market.

* * *

In this issue of the SmallCap Informer, we introduce a very small electronics components maker that could see its shares rocket to outer space.

Stay the course!

Subscribers can read Doug's complete commentary and the in-depth profile of our recommended small company stock in the September 2024 issue of the SmallCap Informer stock newsletter. Not a subscriber? Subscribe to the SmallCap Informer and get monthly small company stock recommendations and updated buy/sell prices for each of the 47 high-quality small company stocks currently covered in the newsletter