August 2024 -
You’re Killing Me, Smalls
Going into the recent Fed meeting, anticipation for the bank to signal that it was nearing the start of rate cuts led small‑caps to outperform larger counterparts by 10% for the month. Unfortunately for those small‑cap investors, who have long been waiting for a recovery in a space held captive by higher‑for‑longer rates, those gains were quickly killed. The next day’s weak jobs report and the untimely move by the BoJ reversed the market narrative around impending rate cuts being supportive for small‑caps to instead reflect that it is too late to help an already weakening US economy. The worse‑than‑expected jobs number follows other recent data suggesting weakness in manufacturing and consumer finances. The view that small‑caps’ vulnerability to higher interest rates would now be allayed amid lower rates has been overwhelmed by concerns about their economic sensitivity, which the market now seems to be prioritising. With the prospects of a soft landing now in question, it’s less likely that interest rate cuts alone will be sufficient to fuel small‑cap outperformance until we see clear evidence that growth is going to be stabilised.
Getting Carried Away
The unfortunate timing of the BoJ’s surprise interest rate hike last week, colliding with the Fed’s decision to delay the start of cutting rates the day before disappointing US labour market data were released, sent global risk assets plummeting. Japanese equities were among the hardest hit after having been the darlings of the developed markets since last year on improving investor sentiment and reflation hopes. The sharp move lower in Japanese equities was exacerbated by the dramatic move higher in the yen as investors scrambled to get out of carry trades where they were short the lower‑yielding yen and long other higher‑yielding currencies. The yen carry trade has been a longtime favourite and crowded trade where significant leverage can be deployed, making today’s unwind concerning as investors could be taking substantial losses as they are forced to buy back yen at much higher levels. This unfortunately comes at a time when the market narrative for US growth has changed just as quickly with fears that the Fed may be behind the curve, and it likely has made the Fed and BoJ’s jobs a lot harder than they already were.
For a region-by-region overview, see the full report (PDF).
Yoram Lustig is the head of Multi-Asset Solutions, EMEA and Latin America, in the Multi-Asset Division. He also is a portfolio manager and the chair of the UK and European Investment Committees.
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