'Fragile rally': Russell 2000 falls short of all-time high after Fed rate cut

The smid-tracking Russell 2000 index briefly hit a record high yesterday, September 17, following the Fed's rate-cut decision. By the close, however, it had given up almost all the gains. Wells Fargo notes that the the rally is fueled by dovish Fed expectations, while BCA Research describes it as “fragile.”

The Russell 2000 rose as much as 2.1% to 2,453.36 points yesterday, surpassing the all-time closing high for the first time since November 2021, before paring some of the gains and pulling back from that level. The gauge closed up 0.2% at 2,407.34 points.

The fresh record – albeit brief – caps off a "stunning" comeback for the Russell 2000, Bloomberg writes. The long-expected interest-rate cut of 25 basis points from the Fed helped propel the Russell 2000 higher, even as the broader market finished the day lower. With about half the stocks on the index not profitable, the rate cut could give a boost to the highly-leveraged group, Bloomberg said. Meanwhile, Fed officials penciled in two more reductions this year.

“A few months ago, small-cap stocks looked dead in the water,” said Irene Tunkel, chief U.S. equity strategist at BCA Research. “Small caps were cheap, unloved, and primed for a rebound. Add expectations of Fed easing, fresh tax breaks from OBBBA, and brighter earnings forecasts, and the rally suddenly had legs.”

The Russell 2000 has gained 36.7% from its trough in April, when expectations of Trump’s America First agenda ushering in a revival in small caps fell flat, Bloomberg writes. The rally coincides with “the risk-on sentiment along with expectations that the Fed will cut interest rates potentially three times this year,” said Doug Beath, global equity strategist at the Wells Fargo Investment Institute. "Interest expense takes a significant share of small-cap earnings, and lower short-term rates would help reduce that burden."

Jefferies Financial Group strategist Steven DeSanctis notes that the macroeconomic backdrop is “conducive” for small-cap stocks. Furthermore, second-quarter earnings for the sector outperformed expectations. “There is an anticipation by later this year or into next year, small-cap earnings growth is going to exceed that of both large cap and the Magnificent Seven,” said DeSanctis.

With small caps' aggregate sales being on track to finally surpass their 2022 peaks, there is more room to climb for the segment, according to Bloomberg Intelligence strategist Michael Casper.

Goldman Sachs strategist David Kostin says there is still scope for small caps to fare better in the near term, though he does expect that to continue over the next 12 months. For Tunkel of BCA Research, ”the rebound has been impressive, but many smaller companies face rising costs and shrinking margins, making this rally fragile."

The AI translation of this story was reviewed by a human editor.