Broker Check

Weekly Market Update May 10, 2024

May 10, 2024

Fed Funds 5.25% - 5.5%, US Ten Year 4.50%, Oil $78.33 


Recent economic data and company results indicate an economy still growing, albeit slower than expected, along with rising labor costs, and persistent inflation which is beginning to dampen consumer spending. “Higher for longer” interest rates are continuing, with CME futures indicating no drop in Fed Funds before September. Stock investors have reconciled themselves to the Fed’s “pause” on interest rates, and that can be a good thing. According to LPL Financial chief equity strategist Jeff Buchbinder, as reported in Barron’s May 6 edition, the past six Fed pauses since 1995 have lasted 240 days on average, and have been particularly good for stocks, with a mean gain for the S&P 500 of about 13%.

While current interest rates are good for large companies which finance themselves in the capital markets and issue bonds, they are a negative for small companies which rely on more costly bank financing. Their need for financing is usually too modest to warrant floating a bond, and they have weaker balance sheets and lower credit ratings than their larger cousins. Their relative stock underperformance is illustrated in the five-year price chart below.

Both the Russell 1000 Large Cap Index (RUI, blue line) and Russell 2000 Small Cap Index (RUT, green line) reached new highs toward the end of 2021, before the severe 2022 correction. Note the much higher level reached by the large cap index at the end of 2021, than the level the small cap index reached earlier in the year. The market is forward-looking. With the huge amount of deficit spending by the government in 2021 and the supply shocks that followed, investors were not fooled into believing that the soaring inflation was “transitory.” Investors anticipated higher interest rates as early as the summer of 2021, months before the Fed began raising rates, and started pulling funds from small cap stocks then, well before they began reducing their large cap exposure.

While both indices corrected in 2022, the large cap index recovered sooner, and much more robustly. Indeed, large cap stocks are making new highs, while the small caps are still well below their summer 2021 peak. They will continue to lag until we see actual lower rates. If you have a portion of your equity portfolio in small cap stocks that are below your purchase price, consider some tactical tax loss selling, especially if you have realized significant gains in stocks in non-tax advantaged accounts. Sell a portion of your losing small cap investments to realize a loss to offset present or anticipated gains. You may also offset up to $3,000 of ordinary income with the loss. You can then repurchase the small cap holdings after 31 days to reestablish the original position without violating the 30-day wash rule. This strategy of course can be used with any security currently trading below cost.

 

Have a Profitable Week,