Small-Caps Lose During Periods of Rate Hikes
The Russell 2000 ETF (IWM), comprised of the 2000 smallest companies in the greater Russell 3000, is a proxy for small-cap public companies.
Small-caps tend to experience amplified interest expense burden as federal policy rates are lifted (as they are expected to be lifted a whole 100bps through 2022). This is because small-caps have a third of their debt in variable interest rates—meaning as rates rise, the interest expense they pay on debt increases (Source: Bloomberg (below)).
The IWM currently sits at a price level of interest to traders around 12/2020 and 1/2021—buyers and sellers fought to push prices beyond ~$192. During this visit to the price level of interest, the Federal Reserve statements of higher future interest rates may act as a catalyst, playing in favor of sellers.
Further, as investors' money flies from unprofitable growth companies to stable, profitable growth companies, IWM faces pressure. 31% of the companies making up IWM are unprofitable, compared to only 5.7% of the Russell 1000 (largest 1000 companies).
This pair of catalysts may be the breaking point of $192. However, from a historical perspective, it seems that small-caps tend to recover their losses during rising interest rate environments approximately a year after the first hike. Meaning a revisit of the ~$169 price level could be an interesting buying opportunity for long-term traders. More research is needed surrounding the recovery of small caps amid increasing rates. Any ideas or supporting research are welcomed. Thanks.
Sources: Bloomberg, WSJ
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Small-caps tend to experience amplified interest expense burden as federal policy rates are lifted (as they are expected to be lifted a whole 100bps through 2022). This is because small-caps have a third of their debt in variable interest rates—meaning as rates rise, the interest expense they pay on debt increases (Source: Bloomberg (below)).
The IWM currently sits at a price level of interest to traders around 12/2020 and 1/2021—buyers and sellers fought to push prices beyond ~$192. During this visit to the price level of interest, the Federal Reserve statements of higher future interest rates may act as a catalyst, playing in favor of sellers.
Further, as investors' money flies from unprofitable growth companies to stable, profitable growth companies, IWM faces pressure. 31% of the companies making up IWM are unprofitable, compared to only 5.7% of the Russell 1000 (largest 1000 companies).
This pair of catalysts may be the breaking point of $192. However, from a historical perspective, it seems that small-caps tend to recover their losses during rising interest rate environments approximately a year after the first hike. Meaning a revisit of the ~$169 price level could be an interesting buying opportunity for long-term traders. More research is needed surrounding the recovery of small caps amid increasing rates. Any ideas or supporting research are welcomed. Thanks.
Sources: Bloomberg, WSJ
(Unfortunately cannot post links to these articles as a basic member; please message me for the sources).
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