‘Higher rates for longer’ is dealing a blow to small cap stocks in Q2 as market participants re-evaluate their portfolios to accommodate the extension of elevated borrowing costs. Market participants have certainly been quick to re-evaluate companies that are reliant on generating new capital within the next 6-12 months.
Volatility In The Russell 2000
The vast majority of the companies in the Russell 2000 index are part of that crowd that will need new financing within the next 6-12 months. Small cap companies rely on new financing to keep the company growing as they are typically pre-revenue, pre-profit, or both. Over the last month, the Russell 2000 index is down -5.71% on those changing interest rate expectations as market participants have placed bets on both higher rates on prospective loans and/or an issuance of shares, leading to share dilution.
Contagion In Other Small Caps
The combination of these two potential outcomes for small cap companies have pushed their valuations lower. The spillover into other small cap names, that aren’t part of the Russell 2000, has also been witnessed. High flying small cap stocks like Joby Aviation (JOBY) and CRISPR Therapeutics (CRSP) have been dealt their fair share of volatility. Over the last month, these companies are down -0.47% and 21% respectively, JOBY just happened to jump 17% over the last 5 days which is why its decline doesn’t seem too bad. Of course, JOBY is expected to generate more revenue than CRSP over the next 5 years on the back of urban air travel.
Looking Forward
While we can almost all but guarantee a bull market in the S&P 500 throughout 2024, we cannot guarantee a bull market in small cap stocks. The most fit small cap stocks, those that have high quick ratios and retain high market share, may be able to weather the storm and returns gains; but the vast majority of these very stocks may suffer without rate cuts.
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