Executive summary:
- U.S. small cap stocks outperformed their large cap counterparts again
- We don't think the race for the White House will have substantial impacts on financial markets
- The Bank of Canada delivered its second straight rate cut
On the latest edition of Market Week in Review, Senior Director and Chief Investment Strategist for North America, Paul Eitelman, and Equity Manager Research Analyst Michelle Batjargal discussed the rotation into small cap stocks in the U.S. equity market. They also chatted about the potential market impacts of recent U.S. political developments and ended with an update on the Bank of Canada’s (BoC) latest rate decision.
Market rotation into U.S. small cap stocks continues
Batjargal and Eitelman began by unpacking the ongoing rally in U.S. small cap stocks, which began July 11 after the Labor Department released data showing that U.S. inflation eased further in June. With a nod to two recent articles on small caps written by Director and Senior Portfolio Manager Jordan McCall—one published when small cap stocks were still struggling and the other published amid the current rally—Eitelman said that the rotation toward small cap stocks continued the week of July 22.
He explained that the Russell 2000® Index of small cap stocks rose approximately 2% on the week, as of market close on July 25, while the Nasdaq 100 Index—which tracks the largest U.S. companies outside the financial sector—declined by 3%. “Similar to the past few weeks, this was a pretty big spread in market performance between small cap and large cap names,” Eitelman stated.
He said that disappointing quarterly earnings reports from a few mega cap companies drove this performance discrepancy. In particular, second-quarter earnings from Tesla and, to a lesser degree, Google parent Alphabet, weren’t as strong as investors were anticipating, Eitelman noted. “Whether or not a company can meet or exceed growth expectations is always an important barometer for investors, especially when it comes to high-flying growth companies like these two. The relative disappointment in earnings among both of these Magnificent Seven members was a drag on mega cap stock performance the week of July 22,” he stated.
Looking ahead, the next few weeks will likely have an even greater bearing on how the rotation away from U.S. large cap stocks plays out, Eitelman said. For instance, four more Magnificent Seven members will report quarterly earnings the week of July 29, he noted “This will serve as an important litmus test around what’s actually happening to the fundamentals of both large and small cap stocks—and should offer clues on whether the rotation into small cap names is sustainable,” Eitelman remarked.
Biden drops re-election bid, backs Harris. Does it matter to markets?
Switching to the upcoming U.S. elections, Batjargal asked Eitelman if there were any market implications from President Joe Biden’s historic decision to drop his re-election bid and endorse Vice President Kamala Harris in the race for the White House.
“From a market perspective, I think this was more about intrigue than substance,” Eitelman said. He explained that most investors expect Harris to run on the same policy platform that Biden has since entering office in 2021. In other words, markets don’t expect any major policy shifts or new initiatives from Harris, who will likely become the Democratic Party’s official nominee for president at its convention next month.
The more interesting question for markets at this point is whether or not Harris’ entrance into the race tightens the contest for the presidency, Eitelman said. He explained that in the weeks before Biden dropped out, former President Donald Trump was consistently leading in most polls and predictions markets, especially in the wake of the June 27 presidential debate and the July 13 assassination attempt. “With Harris poised to become the Democratic nominee, some recent polls and predictions markets are suggesting that the race between her and Trump could be more competitive,” Eitelman remarked.
Beyond this, Eitelman said he doesn’t anticipate the U.S. election season to have a substantial impact on financial markets the next few months. He said that the Russell Investments strategist team’s biggest watchpoint right now is whether a change in the presidency could result in a significant reshuffling of the leadership at the U.S. Federal Reserve (Fed). “This could spark some volatility in markets, so we’ll be paying careful attention,” he said.
Another month, another rate cut in Canada
Batjargal and Eitelman finished with a look at the Bank of Canada’s recent decision to lower its benchmark rate by 25 basis points (bps) to 4.5%. The decision comes on the heels of an initial 25-bps rate cut by the BoC in early June, making the Canadian central bank the first of the G7 (Group of Seven) to cut rates at back-to-back meetings this cycle, Eitelman noted.
The BoC’s considerable progress in bringing inflation back down closer to its 2% target was one of the key factors behind its latest decision, he explained. Eitelman said the bank was also influenced by weakness in Canada’s labor market and overall economy.
“Amid this backdrop, we think the BoC may even cut rates for a third time in September,” he stated, noting that the central bank already has a head start on the Fed, which isn’t expected to start lowering borrowing costs until September.