Friday Reader Question

Every Friday in HX Daily, we want to do one of two things…

One approach will be sharing some insights into concepts or philosophies that we think can be helpful in investing and life. Many of these have to do with human psychology and how we can harness it to our benefit.

The other approach is to respond to reader questions submitted to us over the week.

If you would like to submit a question for a future Friday HX Daily, please email us at [email protected]

Here are a group of questions that were submitted by several readers this week…

The recent massive rotation into small-capitalization stocks and the Russell 2000 has garnered tremendous interest—and it should!

Not because the small-cap stocks are all that important.

We have pointed out before that the market cap of the entire index is less than the individual market caps of the two largest companies in the stock market – Microsoft Corporation (NASDAQ: MSFT) and Apple Inc. (NASDAQ: AAPL).

We have also pointed out that these companies are smaller and more subject to competition and other economic forces, such as interest rates and commodities.

We don't think that small caps doing well is necessary for us to have a long and robust BULL MARKET.

Having them go up, though, sure doesn’t hurt!

Why do we think it is happening right now?

We think this is happening for two reasons, and both are equally valid.

The first is the evolving macroeconomic environment. As mentioned above, smaller companies are more vulnerable to interest rates and commodities.

We are sure you know what is happening with inflation, but here is the chart of the headline Consumer Price Index ("CPI") across the last few years…

In the last two years, this number has gone from 9% to 3%. While 3% is still higher than the target of 2%, it is WAY down from the heights of the post-COVID period.

This reduction in inflation is MOST important because it gives the Federal Reserve the room to cut interest rates.

High inflation can be good and bad for small-cap companies, but high interest rates are almost always bad.

Here is a chart showing market expectations for the Fed Funds a year from now, in July 2025…

Just two months ago, the rate was expected to be 4.65% a year from now. Now, it is likely to be below 4%. That is not a massive change, but it is headed in the right direction!

Even the fact that interest rates are not going UP anymore is a big positive for these companies.

We are not sure you have noticed, but we have also seen many commodities trading lower in the last few months. In the last few months, oil prices have been 10% lower, lumber prices have been 18% lower, copper prices have been 20% lower, and wheat prices have been 26% lower.

This is good for consumers and a positive for all companies, but it is excellent for small capitalization companies!

We think there are real reasons for the rally in the Russell 2000.

It is likely to continue. The economy and inflation will continue to slow, and lower interest rates are still ahead of us. All of these will continue to be positives for small caps.

We can also look back at history and see what has happened when we have seen such sharp rallies in small-cap stocks.

The Russell 2000 just had a +10% rally in 10 days. This is a rare occurrence. It has happened only 22 times since 1979.

Here is an excellent chart from Ryan Detrick of Carson Investment Group showing what happens next.

One year later, the Russell 2000 is up 87% of the time and up almost 27% across this period.

When we DO see a BULL MARKET in the Russell 2000, they tend to be lengthy and extensive.

Here is another great chart from our old friend John Roque of 22V Research…

If the recovery in the Russell 2000 began in October 2023, then we would have +33% in the last nine months. The average BULL MARKET in small caps has historically gone over 33 months and +130%. This means we might have a LOT more to go!

Readers wanted to know if this rotation into small caps was real and sustainable, and we think it is BOTH.