MW This small-cap ETF has lured investors after Fed's nod to rate cuts. Can it keep it up?
By Isabel Wang
Hello! This is MarketWatch reporter Isabel Wang, bringing you this week's ETF Wrap. In this week's edition, we look at small-cap stocks and funds, which many investors think are due for a rebound after Federal Reserve Chair Jerome Powell finally set the table for interest-rate cuts ahead.
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Small-cap stocks were regaining some love on Wall Street.
After the stock market's sharp Aug. 5 selloff, investors finally piled back into small-cap ETFs over the past week as Federal Reserve Chair Jerome Powell finally set the table for interest-rate cuts ahead. However, the ever-shifting interest in small caps has seen some investors weighing whether to bet on their rebound or proceed with caution in one of the most speculative corners of the market.
The iShares Russell 2000 ETF IWM - which tracks the small-cap benchmark index RUT, composed of 2,000 small and midsized companies in the Russell 3000 index RUA - saw more than $688 million in net inflows in the week ending Wednesday. It was one of the five funds attracting the largest amount of capital among more than 950 ETFs that MarketWatch tracked over the same period, according to FactSet data.
The strong investor interest follows a mass exodus from IWM earlier this month, when concerns that the U.S. economy could be heading for recession triggered a global stock-market rout. Investors pulled more than $4 billion out of IWM in the five trading days ending Aug. 7 - the fund's largest five-day outflow since Aug. 31, 2007, according to Dow Jones Market Data.
Thomas J. Mudge III, director of equity research and portfolio manager of small-cap value-equity strategy at Bailard, said academic studies have shown that ETF investors tend to chase returns, putting more money into areas that have recently been performing better.
However, fund flows are sometimes "a poor gauge" of future investment performance and may even be "a contrary indicator," as some investing decisions are based on market sentiment without investors considering valuation levels or "rationally" analyzing future prospects, Mudge told MarketWatch on Thursday.
See: Small-cap stocks are perking up. Here's how to pick winners.
Earlier this year, some investors bet on a significant resurgence for long-suffering small caps in 2024 after a lackluster 2023, with hopes that interest rates would come down and the economy would proceed toward a soft landing.
In mid-July, the long-awaited "great rotation" finally proved that patience can pay off - with small-cap stocks surging into the lead, surpassing the seemingly relentless rally of megacap technology firms. The Russell 2000 in July outperformed the S&P 500 SPX and the Nasdaq Composite COMP by the widest margins since the early 2000s, according to Dow Jones Market Data.
See: Small caps and value stocks dominated in July by the widest margin in decades. Can the 'great rotation' continue?
How small caps tend to perform after rate cuts
Fed Chair Powell's Jackson Hole speech last week sealed the deal for many that an interest-rate reduction is indeed imminent at the central bank's September meeting. Investors want to know how small-cap stocks may react to such a move, as inflation has been on a path back to the Fed's 2% target.
In theory, small-cap stocks are more sensitive to interest rates, the economy and financing conditions than their large-cap peers, noted Alex Bryan, director of product management for equity indexes at Morningstar. "Interest rates help the economy, which indirectly helps small caps, but also directly [help small caps] through lowering their borrowing costs," he said.
See: Will stocks rally or fade after the Fed cuts rates? Here's what history tells us.
Indeed, history shows that small caps, represented by the S&P SmallCap 600 Index SML, were up 3.1% on average one month after an initial Fed rate cut dating back to 1990. The index scored an average gain of around 4.6% in the year following the start of a monetary-easing cycle over that same period, according to Dow Jones Market Data (see chart below).
However, that average belies downtrends for small caps after Fed rate cuts in 2007 and 2019. The S&P SmallCap 600 tumbled more than 15% in the six months and nearly 12% in the year after the Fed started its rate-cutting cycle in 2007, and it slumped more than 4% in both the week and the month after the Fed began easing in 2019, according to Dow Jones Market Data (see chart below).
"Every interest-rate cycle is different - it depends on what's driving the rate policy," Bryan told MarketWatch via phone on Thursday. "[Rate] cuts often happen because the economy starts to slow down. In the current environment, the labor market is starting to slow down, but this is not like the type of rate cuts we had when we were on the edge of recession."
Meanwhile, the current market condition is "unique" due to the surging concentration risk in U.S. stocks, Bryan added. "As investors start to get more sensitive to valuations and more concerned about how concentrated their portfolios are, small caps are better positioned to benefit from their rotation away from the megacap growth stocks," he said.
The Russell 2000 has fallen 0.7% this week, compared with the S&P 500's 0.8% decline and the Nasdaq's more than 2% slump in the same period, according to FactSet data.
As usual, here's your look at the top- and bottom-performing ETFs over the past week through Wednesday, according to FactSet data.
The good...
Top performers %Performance Sprott Uranium Miners ETF 4.3 SPDR S&P Regional Banking ETF 4.2 SPDR S&P Bank ETF 3.8 iShares U.S. Regional Banks ETF 3.6 Global X Uranium ETF 3.2 Source: FactSet data through Wednesday, Aug. 28. Start date Aug. 22. Excludes ETNs and leveraged products. Includes NYSE-, Nasdaq- and Cboe-traded ETFs of $500 million or greater.
... and the bad
Bottom performers %Performance AdvisorShares Pure U.S. Cannabis ETF -13.3 KraneShares CSI China Internet ETF -5.4 Invesco China Technology ETF -4.6 United States Natural Gas Fund LP -4.4 Grayscale Ethereum Trust -3.9 Source: FactSet data
New ETFs
Global X ETFs on Wednesday announced the launch the Global X Infrastructure Development ex-U.S. ETF IPAV, which seeks to provide exposure to companies outside of the U.S. involved in the construction, development and maintenance of infrastructure projects.Krane Funds Advisors on Wednesday announced the launch of the KraneShares China Alpha Index ETF KCAI, which tracks the Qi China Alpha Index and seeks to outperform the CSI 300 Index XX:000300 by applying "a systematic machine-learning approach," the firm said in a press release.VanEck on Wednesday launched the VanEck Fabless Semiconductor ETF SMHX, targeting semiconductor companies that design and develop chips but outsource their manufacturing.
Weekly ETF Reads
Investors Funnel $2.2B Into These 5 Real Estate ETFs In Anticipation Of Fed Rate Cuts (Benzinga)Investors jump into US government bond ETFs ahead of Federal Reserve interest rate cut (Financial Times) Next-Gen ETFs Buck Vanguard Effect With Fees Near Decade Highs (Bloomberg) Bond ETFs For Retirement: Is Now The Time To Move In? (The Street)
-Isabel Wang
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August 29, 2024 18:16 ET (22:16 GMT)
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