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Investing.com - Small- and mid-cap stocks outperformed their large-cap peers on Wednesday, as investors eyed the potential for upcoming Federal Reserve interest rate reductions.
A soft July jobs report, as well as muted inflation data for the month, have fueled increased expectations that the Fed will slash borrowing costs at its September meeting. It would be the first drawdown by the central bank since it paused its policy easing cycle last December.
Investors are now all but pricing in a 25-basis point reduction after the Fed’s September 16-17 gathering, with Investing.com’s Fed Rate Monitor Tool now seeing the probability of such a move at over 99%. Treasury Secretary Scott Bessent, meanwhile, has called for an even deeper half-point cut due partially to sharp downward revisions in job growth in June and May.
Smaller U.S. companies stand to be possibly boosted by rate cuts, as they may help to decrease borrowing costs that hit them disproportionately more than bigger firms. A drawdown could, in theory, promote spending and investment as well, possibly fueling economic growth.
Against this backdrop, S&P indices for mid-sized companies and small-caps rose by 1.6% and 2.1% on Wednesday, respectively, exceeding a gain of 0.3% in the large-cap-focused S&P 500.
"Of course, the explanation for why the small- and mid-caps might outperform the large-caps for a while is that they should do better if the Fed is about to lower the federal funds rate some more, as is widely expected," analysts at Yardeni Research said in a note.
But they tempered expectations for a run of outperformance in small- and mid-caps, flagging these stocks are "cheap for a reason." In particular, they highlighted "flatlining" forward earnings estimates that have paled in comparison to record highs posted by S&P 500 groups.
"We doubt that the forward earnings of the small- and mid-caps will finally start rising just because the Fed starts easing again," the Yardeni analysts said.
These stocks also lagged larger counterparts when the Fed last cut interest rates by 100 basis points between September and December last year, they noted.
However, on a sector-basis, small- and mid-sized financials and industrials could outperform similar large-caps, they argued.