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Rate Cuts Could Be Meaningful for Small-Cap ETFs

Over the past month and the past 90 days, the Russell 2000 Index is higher by 12.07% and 8.49%, respectively. What’s notable about those periods is that they include increased chatter that the Federal Reserve could be positioning for multiple interest rate cuts in 2024.

In other words, small-cap stocks are positively correlated to the concept of lower rates. That could signal opportunity with exchange traded funds such as the Invesco NASDAQ Future Gen 200 ETF (QQQS). Before getting too excited about the prospects for small-caps in 2024, investors should acknowledge a few points. For example, rate cuts could be interpreted as the Fed being concerned about economic activity. That could weigh on smaller companies.

The other side of the coin is more constructive for assets such as QQQS. Higher quality companies should be responsive to rate cuts. If Fed dovishness arrives with the economy still strong, the Invesco ETF could benefit.

Macro Factors Could Help QQQS

At least two areas could provide tailwinds for small-cap equities in 2024: supportive economic data and bullish earnings per share revisions.

“From here it’ll be important to watch relative earnings revisions, high frequency macro data and small business confidence for signs that a more durable period of cap outperformance is coming,” noted Mike Wilson, chief investment officer and chief U.S. equity strategist for Morgan Stanley. “For now, relative earnings revisions remain negative for small caps and relative margin estimates have just recently taken another turn lower. Meanwhile, purchasing manager indices remain below the expansion contraction line of fifty and small business confidence remains low in a historical context and is yet to turn convincingly higher.”

Other factors that could act as 2024 catalysts for QQQS include the current rock-bottom valuations on small-cap stocks that some market observers argue are making the asset class too compelling to ignore and an uptick in healthcare mergers and acquisitions. Those factors are relevant to an ETF that devotes more than half its weight to that sector.

More broadly, ETFs such as QQQS can extend their recently bullish ways in 2024. But much of that thesis is data dependent, meaning lower inflation and higher GDP could be essential to small-caps’ fortunes next year.

“For this trend to continue beyond that, we will need to see nominal GDP reaccelerate and for inflation to stabilize at current levels rather than fall further toward the Fed’s target of 2%. While this may seem counterintuitive, we remind listeners that the average stock does better when inflation is rising, not falling and that may be what the market is now anticipating,” concluded Wilson.

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