Small-cap stocks never participated in the 2023 market rally.
The main small-cap index, the Russell 2000 (^RUT), is just above flat this year. Meanwhile, the tech-heavy Nasdaq (^IXIC) rose nearly 30%, and the S&P 500 (^GSPC) rose 13%.
Recent work by Bank of America’s strategy team highlights a key issue facing small-cap stocks that is likely to scare investors: debt.
As the Fed has been raising interest rates at a historically fast pace, investors are increasingly concerned about how businesses and consumers will transition from the low interest rate regime of the 2010s to one with much higher costs of capital.
As Bank of America’s chart shows, Russell 2000 companies are more at risk because they have a higher maturity ratio of long-term debt. Faster, which means if you need more, you will have to pay higher interest rates in the near future Capital to operate.this will Corporate profits may shrink, negatively impacting profits.
“Despite the fastest upcycle in more than 40 years, we believe the impact on S&P 500 returns is manageable,” Bank of America’s equity strategy team said in a research note Wednesday. Ta. “The real risk lies with the Russell 2000.”
The Fed is likely to keep interest rates high for a longer period of time than initially expected, which could also pose problems for small-cap stocks with longer debt maturities.
“Unless interest rates reverse and fall, interest costs will continue to weigh on small-cap earnings,” Ed Clissold, chief U.S. strategist at Ned Davis Research, said in a Sept. 21 research note. Ta. This is one of the reasons why we prefer large-cap stocks over small-cap stocks. ”
However, Clissold emphasizes that not all companies are spooked by the high interest rate environment.
Interest expenses for S&P 500 companies skyrocketed as the Fed raised interest rates. Expenses for the second quarter increased by 64.3% to $37.21 per share, the highest level since the second quarter of 2008. However, non-operating income, which includes income earned from interest on cash balances, amounted to $6.86, an increase of nearly 89% over the prior year. one quarter. The gap between expenses and non-operating income remains below 2000s levels, according to Ned Davis Research.
Mega Cap technology companies are also doing better. Over the past four quarters, Meta (META), Microsoft (MSFT), Adobe (ADBE), and NVIDIA (NVDA) have generated nearly $1 billion more in non-operating income than interest expense, according to Ned Davis Research. .
So it may not be surprising that the 2023 rally was largely led by mega-cap tech, with very few small-cap stocks included.
Josh Schafer is a reporter for Yahoo Finance.
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