Capitalist Investor

Small Cap Stocks and Treasury Yields: A Deep Dive, Ep. 263

• Strategic Wealth Partners

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The latest episode of Capitalist Investor, hosted by Luke, Tony, and Derek, packed a punch with robust discussions on several pressing financial topics. Here's a recap of the five hottest topics discussed during the episode:

1. Small Cap Stocks Surge
Small cap stocks have been on a tear recently, showing significant upward momentum. The hosts attribute this movement to declining interest rates, which lower borrowing costs and spur growth for smaller companies. This has allowed these stocks to finally start catching up after being overshadowed by market giants in recent years.

2. Market Rotation and Breadth Widening
A substantial market rotation is under way, with money flowing out of the high-flying tech giants and into undervalued small cap stocks and international markets like Mexico and India. The hosts noted that while some big-name stocks have started to decline, the broader market seems to be playing catch-up. As a result, small caps and other international ETFs are experiencing healthy rallies.

3. Interest Rate Cuts on the Horizon
With the Federal Reserve signaling potential interest rate cuts later this year and into the next, the discussion naturally veered towards the impact this will have on different asset classes. The hosts predict a substantial number of rate cuts by the end of next year, possibly taking the federal funds rate down to 2.5%. This anticipated reduction could breathe new life into sectors struggling under higher interest rate conditions.

4. Inflation and Economic Concerns
While discussing rate cuts, the hosts expressed concern about the potential for renewed inflation. They also highlighted the risks in the job market, noting an increase in unemployment rates. The balance between lowering rates to spur economic growth and the risk of inflation looms large, with thoughts diverging on whether we are headed for a soft or hard economic landing.

5. Shifts in Personal Investment Strategies
To bring a personal touch to the financial talk, Luke shared his decision to sell his house, believing that the real estate market may take a hit during a potential recession. Meanwhile, Tony discussed how the current financial climate emphasizes the need for active investment management over passive strategies. The hosts stressed the importance of continuously reviewing and refreshing investment plans to adapt to the changing market conditions.
This episode was a treasure trove of insights, blending macroeconomic analysis with practical investment advice. If you missed it, make sure to catch up and stay ahead of the financial curve with Capitalist Investor.

Hello and welcome to this episode of the Capitalist Investor. As always, you have me, Diamond Hands D, and we got the whole crew here. Tony the tiger, cool hand Luke. What's going on, guys? What's up? Yeah, there's the energy. Hey. Yeah, well, nothing gets me pumped up more than talking about small cap stock. Small cap stocks. I mean, let's be honest. And treasury yields, it's the stocks that I can win the most and lose the most. Let's go. I mean, I'm

in here, you know, 09:

00 a.m. my hair on fire. Just want to talk to everyone about small caps and the biggest big move that they've made in the last couple of weeks. Just been a rocket ship. Yeah, really? It's literally just been a graph, like, what's it called? Right angle, just straight up. Right. So the reason they're probably up is interest rates. Right. And when interest rates are going to come down, that means that borrowing costs should be in line with, you know, I guess, like, they're going to be able to do a lot more research and development, you know, cost of money to borrow, because usually a small cap stock is not sometimes a profitable company. So, like, they have to support debt too, with their cash flow. So, you know, borrowing costs go down. This is good for small cap stocks. There whispers that there's a hundred percent, you know, 25% basis cut for the Fed in September and maybe another one after that. So, you know, the borrowing costs are coming down, therefore the mid and small caps are reaping the reward. Right. And I know that's something that our investment team has been focusing on, because think of last year, the stock market was essentially propped up, what, 80% of the returns came from seven stocks. Is that kind of the statistic? Well, one of two things needs to happen this year, right? Everything else, the other 493 stocks need to catch up or those seven stocks need to come down. But they, there usually should be some type of balance, right. And right now, the dispersion is immense. So I think we're starting to see a combination of both. The seven are coming down slightly or just flat. And the, the other, the other stocks are coming up. Well, as we're talking, I don't know exactly when this podcast is going to be a bullies. As we're talking, the market is down currently 2%. This might be the Nasdaq's down two, and the S and P 500 is down one. This may be one of the biggest drawdowns we've seen so far this year. There hasn't been any kind of big drawdowns. Yeah. Nasdaq is now 2.4% and the S and P is down over one. So what's, let me check real quick. Just, yeah, Nvidia is down like five and stuff. And the semis are down. The small caps are barely down. Small caps, 3%. This is the rotation that everyone's talking about. People are selling Nvidia. People are, you know, I tweeted last week, I mean, 4 July, you know, very thankful. You know, they call up the young buck during holidays on Fox News. And I was talking to Kavuto and I was like, you know, I think you'll see some, the typical inverse relationship between bonds and interest rates. Like, you're going to see that start playing out because, you know, yields really haven't done anything. And I think that, you know, if we think rate cuts are going to happen, if we think that, you know, possibly weaker inflation data signaling possibly recession like, when yields go down, bond values go up. So you want to rotate outside there. But also, us stocks have been the place to be. Like the us financial markets have been the place to be. So I think there's going to be a rotation trade outside of us stocks in places like Mexico or India that we own, like those kind of areas. And you're seeing that happen right now over the past week and a half. And that's part of the Trump trade that we've talked about. But it's also part of when too much money goes to one place, people start taking profits and then they allocate that money to areas that are undervalued, small caps being one of them. They were still down 20%, I think, just a few weeks ago. Now they're down 10% from the top, which still 10% from the top, but they've gained 10% in a few weeks. And then you're seeing Mexico ETF rally like 10%, seeing India rally another 10%. So the money is truly coming out of the top, names was saying, and the breadth is widening a little bit. But that doesn't mean that. But what's interesting, I'm late. I've talked about this like, two years ago or a year ago, I said that you'll see stocks go higher and maybe the indices go lower. I think that's what's happening, because when the top seven stocks make up 30% of the index, if those seven stocks drop while the other 70% go up, the S and P 500 and the Nasdaq could actually drop while all the other stocks are making money. But most people would say, oh, well, my mark, the markets down 10% might, you know, because they own the S and P 500. That's the problem with passive investments. And I think you're seeing that play out. That's the thing. The active investment side is where, you know, I feel like we, my, our investment team brings a great diversifier, you know, a lot against a lot of other advisors where we aren't just piled into the stocks that were, you know, hot money last year. Yep. You know, it's, it's, it's a well diversified strategy, and over a long period of time, that strategy will play out. Does it play out in six, in a six month period? Maybe not all the time. Yeah, play a six month period when seven stocks go up and carry the whole weight of the s and P, especially when a lot of our clients are in a growth in income dividend or value strategy that then of course it's not going to play out when four to the stocks don't pay dividends. Now, devil's advocate on this though is, you know, there's the statistic that says that there's $6 trillion sitting in cash and money markets and things like that is, is a six or ten or 15% pullback in Nvidia, the time where that money starts coming alive. Right? Like, oh my God, this is the opportunity I need to get in for this futuristic stock. If Nvidia got cut 30%, I would say probably. Probably now's the time. Like, I think a 30 or 40% top, and that might not come for another year. It might be down in the same price it is now after a rallies another 50%. I don't think that's probably likely, but I think 30% haircuts probably eventually gonna happen. That's probably the time. And it's natural. You saw the Nasdaq down almost 30% during 2022. Yeah, but I mean, if you see the, you know, just the chart on Nvidia, it's a hyperdevelop, it's parabolic line, it's, it's an exponential, it's crazy. It's straight up in a short period of time. Right. And that's not sustainable. So you have to assume that something needs to correct or happen. It's just timing it, which is not a good game. Somebody make a forecast about Nvidia saying it's gonna be a $50 trillion company. 50 trip, 50 trillion trillion by 2030. What did you say? When did you say bitcoin was going to be a million or something. Yeah. And now we put it like at 10 trillion or something like that. No, that put it at like 20 trillion. But that's, that's replacing gold, that's replacing all the different other asset classes. But Nvidia being $50 trillion company basically like two and a half times us GDP, like. No, yeah. Not realistic. No. But yeah, you know, I think, I think everything we've talked about, it's, and Tony mentioned it briefly, it's, it's kind of what has to happen. It's like a, you know, natural balance type of thing that is really healthy for the market. And we talked a little bit, you know, in a recent episode about planning and, you know, not basing a lot of your decisions on, like, short term results. This is a classic example of that. Right. So if you were piled heavily into those seven stocks, you probably have done great for the last twelve months. That's not going to continue forever. If you're putting new money into the market, you just don't want to put it into what's performed best this year. Understanding risk adjusted return, I think, is a huge part of planning and investing. And I think what's happening now where we've been tracking and talking about interest rates for two years now, and it appears that we finally made enough headway where they're going to start coming down a little bit and hopefully, and hopefully with maybe a Trump presidency that is going to kick off a more normal economy, which is what we've been trying to get to for the last four years really well. It is interesting. Ten year treasury dropped from 5%, down like 4.15 now, percent low over four. I've been talking with a lot of clients, people in general, about how that 5% savings account is not going to be 5% for probably much longer. So now you have to balance the act of what's the risk reward of keeping money on sidelines as cash and then deploying that money into more money making areas, stock market or other areas. Right. So there's going to be a balancing act from a risk reward standpoint over the next year. And one of the reasons why even annuities, like you'll see annuities right now, if they're part of your financial plan, like they're paying out pretty good because these annuity companies, insurance companies, invested their. Locking in these 5%, four and a. Half, 5%, 30 year treasuries because they used long duration bonds. So they locked in these higher rates so they're able to pay out more. That's not going to last forever either. So it's just that's kind of where things have been different for about a year than they have been in 25 years. With rates higher, things are going to be a lot different probably in about a year and a half as rates come down. And you have to reposition that. And that's why, again, we've talked about before why we do plan refreshes to make sure that how it's set up is how it should be. I mean, that doesn't mean we won't get on the phone, call and call people if things actually change dramatically. But those review meetings are very helpful in refreshes. So what do you think we think, are we agreeing with the rate cut in September? And do we think there'll be one, two, three? How many more rate cuts or how many rate cuts, I should say, do we think will happen this year? All right, bearish. Luke is going to come back out. I think we'll probably be at a two and a half percent fed funds rate by the end of next year. End of next year. But he's talking this year we're basically getting cut. You can call that eight rate cuts by end of next year. And how many this year, you think? 2 September, December 6 next year? Yep. I was going to say two this year. I think two and a half by the end of next year might be a little low, but it's definitely headed that way. And, you know, we've been talking about it. So I assume you're saying that because you're thinking that we're going to head into like a recessionary or mini recession. Type of unemployment will continue to rise. I think, I think Powell, even though he didn't want to say it, pal, hinting in the interview that the job market has normalized and it's no longer like too hot. I think he basically was saying, I'm a little concerned about the job market breaking and we're prepared to cut rates as that continues to happen. So you saw now unemployment jump from like three point, what, six to like 4.1 now, right. Like if it gets upwards of five, like that's when things start to really break. And then when you have a debt economy and you have delinquencies ticking up and people start losing their jobs and you have a snowball effect. So I think that the Fed is going to have to balance that hard landing, soft landing narrative. I think we're probably going to lean more towards a hard landing than a soft. Yeah, but the cuts with the cuts, I believe, is going to spike inflation again. I'm more worried about deregulation and tariffs from Trump. That is, deregulation is great from a long term organic growth side. Terrorists aren't necessarily good for that, but those are inflationary. I'm more worried about that. Yeah, I know that's part of Biden's conversations on this is like, you're. You're gonna raise taxes by jacking up tariffs because you're gonna make everything here more expensive. Just trying to keep the jobs here, though, is. I mean, it's. I don't know, but obviously the market's not worried. It's a double edged sword. The only thing is, is that Powell's target was 2% inflation. I don't think we're ever gonna get back there without, like, some serious issues going on. Yeah. So I. But I do believe, and he doesn't. He start, he just started talking about it is the job market. If the. Luke, I think you kind of hit the nail on the head there. If we start getting, you know, north of 4% unemployment, which we're at like four right now. Right? Yeah. Like, if we get closer to five. Yeah. Like, then it's on the table. Because I. I might say, like, there's one rate cut if, if that, like, I'm going zero to one this year. Nice. I don't know if that's bearish. Whatever. Bullish. Bullish. I would say zero to zero to one. Maybe. Maybe one. I think the bond market has been wrong for two and a half years. I think it's finally going to start to be right. I agree. And they're pricing it in two this year. Yeah. September. And that. That. They always say they're the smartest people in the room. They haven't been to, but they might be. Yeah. That has not been true. All right, well, we will. We shall see. It's definitely getting into rate cut season, as they say. So hopefully. Is that what they said? It's the rate cut season, baby. It's also earning season. Maybe we'll have something to talk about next week. Yep. Maybe. Maybe more, hopefully. Actually, hopefully we don't talk about Trump as much, but hopefully it calms down everything. Yeah, hopefully we get some, you know, good vibes going. Right. I think. I think we're on. I think we're on a good vibes that have been increased from the, from the prior. I've been happier, mainly because my house is under contract, but congratulations. Yeah, congrats. I'm not gonna lose my equity when the recession happens. All right, well, we'll monitor Luke's position of the sale of his house to see if that was a good move. But he said, I'm not gonna lose any money. It's like, what are you gonna invest your money in? I'm just gonna be. Because that. Yeah, that's gonna go up. I'm just. That's. That's. That's for you guys to bullish out. He's bullish. Yeah. He's selling high, and he's gonna invest, and it's gonna go up. Costco puts the old one two. No, it's calling. The money's going into my wedding, is what it's called. Yep. Can. All right, $100,000 wedding. Let's go. Just about ten. It's actually. We're keeping it cheap. All right, guys. Well, thanks for listening this week. If you have any questions or comments, hit us up at info@swpconnect.com and we'll talk to you next time.