Welcome to RBC’s Markets in Motion podcast, recorded October 7th, 2024. I’m Lori Calvasina, Head of US Equity Strategy at RBC Capital Markets. Please listen to the end of this podcast for important disclaimers.
The big thing you need to know: Small Caps got a boost from the better-than-expected jobs report on Friday, reinforcing our belief that a return of economic tailwinds is the catalyst they need to take valuation and positioning to the next level.
If you’d like to hear more, here’s another 3 minutes.
Now, let’s jump into the details.
Our Main Takeaway: Small Caps Got a Boost from the Jobs Report on Friday, Adding to Our Belief That a Return of Economic Tailwinds Is the Catalyst They Need to Outperform
Friday’s big news in US financial markets was the much better-than-expected jobs report, in which monthly jobs growth posted a significant upside surprise and big improvement vs. the prior month, and the unemployment rate unexpectedly fell. Not surprisingly, pricing for Fed cuts was reined in. One thing that might have been a surprise for some was that despite lowered expectations for the Fed, Small Caps posted strong gains on the day. Indeed, at the close, the Russell 2000 was up 1.5%, handily beating the S&P 500.
The big move in Small Caps on Friday is only surprising to some extent because their fate throughout 2024 has mostly been a function of increasing or decreasing dovishness around the Fed.
But equities focused more on the strengthening of the soft-landing thesis on Friday than the dialing down of Fed cuts, benefiting Small Caps, which we see as a healthy, and completely reasonable, development for this overlooked corner of the US equity market. Indeed, over time Small Caps have tended to outperform Large Caps when jobs growth is ramping up, and to underperform Large Caps when jobs growth is deteriorating or stagnant.
It’s worth noting that Friday’s jobs report was just one of several positive developments for the soft-landing thesis and the Small Cap trade last week. Another was the ISM services release, where the headline index moved up vs. the prior quarter and beat expectations. Over time, we’ve seen a decent relationship between Small/Large performance and trends in this indicator.
US economic surprises also continued their recovery into positive territory.
This is all against the backdrop of some modest improvement in 2024 and 2025 GDP consensus forecasts.
We’ve been arguing that Small Caps are no longer cheap and oversold, and that while they have room to run on both positioning and valuation, they’ve needed something besides Fed cuts to get them to the next level. We’ve theorized that a return of economic tailwinds could be that new catalyst. Friday’s outperformance in the R2000 following the jobs number increases our confidence in that idea.
The only thing tempering our enthusiasm for Small Caps a little after last week’s good economic news is that positioning in R2000 futures, while not quite back to past all-time highs, got a lot closer to them in Friday’s update. But we think valuations have more room to run.
That’s all for now. Thanks for listening. And be sure to reach out to your RBC representative with any questions.