Stock recovery falters as Netflix prepares for big tech earnings to start

Many equity strategists began the year touting a rebound in small-cap performance as the consensus believes the Federal Reserve will begin cutting interest rates in the first half of 2024. Now, with the market backing away from its hopes for a rate cut this year, the Russell 2000 is down. Small caps (^RUT) are up about 3% year to date, an underperformance of the S&P 500's gain of more than 5% this year.

“We think the Russell 2000 may be a bit challenged in the near term until we get to kind of greater confirmation that inflation is slowing and greater confirmation that the Fed will be able to start lowering interest rates,” the Bank of America president said. Jill Carey Hall, of US SMB Strategy, told Yahoo Finance.

After recent conversations with investors, Hall said the main catalyst for small caps to rise is more clarity on the Federal Reserve's interest rate path.

Market consensus has shifted to expect two rate cuts this year from seven cuts in early January, according to Bloomberg data. The move put a major damper on small-cap stocks' rally to close out 2023, while large-cap stocks clung to this year's gains despite the Fed's changed rhetoric.

The main difference is corporate debt structures. Small businesses have more than 40% of their debt exposed to higher rates either in the form of variable rate loans or short-term debt that may need to be refinanced amid a rising interest rate environment. This compares to roughly 75% of S&P 500 companies, which have long-term fixed-rate debt, according to a Bank of America research team.

Add to this that large-cap companies often have more money that could benefit from higher interest rates and that the Fed not cutting interest rates is simply more costly for smaller companies than larger ones.

“the [Russell 2000] “The index is very sensitive to credit and interest rates,” Hall said. “Refinancing risk is a key risk for these companies because large-cap companies have been able to secure a lot of long-term, fixed-rate debt… the longer interest rates stay high, and that It becomes a greater and greater threat to their profits [smaller cap] companies.”