The Impact of the Federal Reserve’s Rate Path on Small Caps and International Stocks

The recent announcement by the Federal Reserve regarding their higher-for-longer rate path has raised concerns about the recovery prospects for small cap and international stocks. However, one strategist believes that despite the potential delays, investors should not overlook these assets. This article delves into the performance of small cap and international stocks, the impact of the Fed’s monetary policy, and the investment opportunities they present.

Lagging Performances

Throughout the year, small cap and international stocks have underperformed compared to the S & P 500. While the S & P 500 has gained over 12%, the S & P Small Cap 600 has experienced a decline of 1%. Similarly, the iShares Core MSCI International Developed Markets ETF (IDEV) has only achieved a modest gain of 5%. These lackluster performances have raised concerns among investors and prompted a closer examination of the factors at play.

The Influence of the Federal Reserve

The uncertainty surrounding the Federal Reserve’s future monetary policy has significant implications for the performance of small cap and international stocks. In their recent projection, the Fed announced one more rate hike for the remainder of the year and fewer rate cuts in 2024. This announcement has heightened the possibility of a further pullback in equities, causing anxiety among investors.

According to CFRA chief investment strategist, Sam Stovall, the higher-for-longer rate path may result in a delayed resurgence for mid- and small-cap stocks. Stovall suggests that these stocks, which are currently trading at attractive relative price-to-earnings (PE) discounts, may take longer to regain their leadership position. The extended timeline for rate cuts could impact the speed at which these stocks recover and regain market momentum.

Investor Consideration

Despite the potential delays, Stovall emphasizes that small cap and international stocks are still worth considering as investment opportunities. Notably, these assets are trading at attractive valuations, making them potentially lucrative options for investors. Furthermore, once the Federal Reserve initiates rate cuts, these stocks could witness a sharp and robust recovery, offering significant returns for investors.

To assist cautious investors in navigating the current market conditions, Stovall highlights his personal favorites: the Pacer Global Cash Cows Dividend ETF (GCOW) and the Pacer U.S. Small Cap Cash Cows 100 ETF (CALF). GCOW tracks large-cap stocks in developed markets and CALF tracks 100 companies in the S & P Small Cap 600 Index based on free cash flow yield. While GCOW has gained over 8% this year, CALF has experienced an impressive increase of 15%. These exchange-traded funds specifically focus on cash cows, which are stocks that generate stable cash flows with relatively low risk. As a result, they are considered reliable holdings during challenging times. Stovall suggests that if a turnaround in small and international stocks does occur, these funds would likely benefit. Additionally, they are expected to hold up well even if the recovery is further delayed.

The Federal Reserve’s higher-for-longer rate path has raised concerns about the recovery prospects for small cap and international stocks. The potential delay in their resurgence has captured the attention of investors. However, despite these challenges, these assets should not be overlooked. With attractive valuations and the potential for a strong recovery once rate cuts are implemented, small cap and international stocks offer promising investment opportunities. Moreover, funds like GCOW and CALF provide investors with reliable options during times of market uncertainty. While caution should be exercised, these assets have the potential to generate significant returns for investors who carefully navigate the current economic landscape.

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