Bank and Small-Cap Stocks Surging on Rate Cut Hopes

Bank and Small-Cap Stocks Rally on Fed Rate Cut Speculations

In July, the SPDR S&P Regional Bank ETF (KRE) saw a significant increase of 12.5%, driven by speculation about potential Federal Reserve rate cuts starting in September. This development is reminiscent of 1995, when bank stocks surged by 54% following a pause in rate hikes by the Fed. Despite the modest second-quarter earnings reports from banks, analysts are optimistic, particularly about Western Alliance (WAL) and New York Community (NYCB) as potential beneficiaries if rates decrease.

Small-cap stocks are also on an upward trend, with the Russell 2000 Index rising for five consecutive days and gaining over 11% in the past month. This increase is partly due to a surprising drop in the June consumer price index and comments from Fed Chair Jerome Powell suggesting earlier-than-expected rate cuts. David Kostin of Goldman Sachs notes that small-cap companies are highly sensitive to interest rates, so lower rates could boost their earnings significantly. The earnings outlook for small caps is improving, with potential growth parity with the S&P 500 by late 2024. However, some experts warn that the rapid rise of small-cap stocks may be premature. In summary, while bank and small-cap stocks are rising on hopes of Fed rate cuts, it remains essential to monitor earnings and economic indicators closely.

Key Takeaways

• SPDR S&P Regional Bank ETF (KRE) witnessed a 12.5% rise in July due to the expected Fed rate cuts.
• In 1995, bank stocks surged by 54% following a Fed pause, hinting at potential gains despite Q2 earnings.
• Western Alliance (WAL) and New York Community (NYCB) could substantially benefit from lower rates.
• Small-cap stocks, exemplified by the Russell 2000, rallied by 11% in just a month on the back of lower inflation and the anticipation of Fed rate cuts.
• The earnings outlook for small caps is improving, with projections aligning closely with those of the S&P 500.

Analysis

The anticipated cuts in the Fed’s rates are boosting both the SPDR S&P Regional Bank ETF (KRE) and small-cap stocks like the Russell 2000. Western Alliance and New York Community are poised to reap the rewards. Lower rates are easing the pressure on small-cap earnings, amplifying their potential for growth. However, the rapid upsurge raises concerns about overheating, emphasizing the need for cautious optimism amidst the evolving economic landscape.

Did You Know?

• SPDR S&P Regional Bank ETF (KRE):
  • The SPDR S&P Regional Bank ETF (KRE) is an exchange-traded fund that tracks the S&P Regional Banks Select Industry Index, encompassing regional banks across the United States. These banks are typically smaller than major national banks and focus on specific regions, rendering them more responsive to local economic fluctuations and interest rate variations.
• Russell 2000 Index:
  • The Russell 2000 Index is a stock market index gauging the performance of approximately 2,000 small-cap companies in the Russell 3000 Index, representing about 10% of the total market capitalization of that index. It serves as a pivotal indicator of the overall well-being and performance of the small-cap segment in the U.S. stock market, often seen as a barometer for the broader economy due to the significant role played by small businesses in job creation and economic expansion.
• Goldman Sachs' David Kostin:
  • David M. Kostin holds the position of chief U.S. equity strategist at Goldman Sachs, a premier global investment banking, securities, and investment management firm. As a distinguished analyst, Kostin delivers insights and forecasts on the financial markets, with a particular emphasis on equity strategies. His commentary commands high esteem and frequently influences investor decisions and market trends.