Smaller Fed Cut May Bring Small Cap Reversion, RBC’s Calvasina Says

Summary

In the discussion, Jon and Laurie delve into the vulnerability of small-cap stocks in the wake of potential Federal Reserve interest rate cuts. With the market anticipating a 50 basis point cut, small caps surged, but Laurie warns that if the Fed only delivers a 25 basis point cut, there could be a reversion. She notes that small caps are currently fully valued and positioned, contrasting with their under-owned and cheap status a few months prior. Laurie emphasizes the need for a strong economy with above-average GDP growth, suggesting that a soft landing with only 1.5% to 2% GDP growth won't suffice for small caps; they need a more robust 2.5% to 3% or better.

Takeaways

• 🏦 The discussion revolves around the potential impact of a 25 basis point interest rate cut by the Federal Reserve on small cap stocks.
• 📈 Small cap stocks surged on optimism about a 50 basis point cut, but there's concern about their vulnerability if only a 25 basis point cut occurs.
• 📊 Current valuations for small caps are considered full, and market positioning is also full, unlike a few months ago when they were undervalued and underowned.
• 📉 There's a worry that if the Fed cuts by only 25 basis points, there could be a reversion in small cap stocks, as they were propelled by fast money crowd and passive flows, which can be fickle.
• 💼 The economic data and the state of the economy play a crucial role in the performance of small caps, with the need for a delicate balance between growth and stability.
• 📉 Small caps typically perform well during cutting cycles, but a recession could change the investment strategy to selling into the recession and buying on the way out.
• 🚀 For sustained outperformance, small caps need an economy that's not just growing, but growing above average, with GDP growth of 2.5% to 3% or better.
• 🔍 The conversation highlights the importance of economic indicators and how they can influence investor sentiment and market behavior, especially for small cap stocks.
• 💭 There's a nuanced view on the Fed's actions and the economic backdrop, suggesting that the market's reaction to Fed decisions is complex and multifaceted.
• 🌐 The discussion implies that global economic conditions and the Fed's policy decisions are closely watched by investors, especially in the context of small cap stocks.

Q & A

What is the significance of the number 25 mentioned in the transcript?

The number 25 refers to a 25 basis point interest rate cut by the Federal Reserve, which is a topic of discussion regarding its impact on the market, particularly small cap stocks.

Why did small cap stocks surge on Friday as mentioned in the conversation?

The surge in small cap stocks was attributed to renewed optimism about a 50 basis point cut by the Federal Reserve, which was anticipated to be positive for these stocks.

What does the term 'valuations are full' imply in the context of small cap stocks?

When the speaker says 'valuations are full,' they mean that the current price of small cap stocks reflects all known information and may not be undervalued or under-owned as they were a few months ago.

What is the concern expressed about small cap stocks if the Fed only cuts by 25 basis points?

The concern is that if the Fed cuts by only 25 basis points instead of the 50 that propelled small caps higher, there could be a reversion or a drop in the performance of small cap stocks.

Who is driving the recent trade in small cap stocks according to the discussion?

The recent trade in small cap stocks is being driven by the 'fast money crowd,' indicating that the investments are more speculative and potentially short-term in nature.

How does the type of economic growth impact small cap stocks according to the transcript?

Small cap stocks need a strong economy with above-average GDP growth to perform well. A soft landing with low GDP growth may not be sufficient for small caps to continue their outperformance.

What historical pattern is mentioned regarding small cap performance during a cutting cycle?

In past cutting cycles, small caps have done very well and started a longer-term outperformance cycle. However, if a recession occurs, the strategy shifts to selling before and buying after the recession.

What is meant by 'threading the needle' in the context of small cap stocks?

The phrase 'threading the needle' refers to the delicate balance required for small cap stocks to continue performing well. It means avoiding a recession while still achieving strong economic growth.

What percentage of GDP growth is suggested as necessary for small cap stocks to thrive?

For small cap stocks to really thrive, the GDP growth needs to be around 2.5% to 3% or better, as mentioned in the transcript.

What is the implication of passive money flows into small cap stocks as discussed?

Passive money flows into small cap stocks are described as 'very, very fickle,' suggesting that they can be unstable and may lead to sudden shifts in the market.