Federated Hermes’ Chiavarone On The Setup For Small-Cap Outperformance

Steve Chiavarone, Senior Vice President, Senior Portfolio Manager, Equity Strategist, and Head of the Multi-Asset Group at Federated Hermes, joined Keith Black, Managing Director of RIA Channel, to discuss the macroeconomic and political developments that may set the stage for the outperformance of small-cap stocks.

Federated Hermes has published a full-year GDP growth forecast of 2.4%, with resilient economic growth for the rest of 2024. While the disinflation trend will continue, Chiavarone does not anticipate CPI to reach 2% soon.  This forecast gives the Fed room to cut rates, but will not be forced to do so due to recession fears. At the beginning of 2024, the market forecast that the Fed would cut rates six times, while the view from Federated Hermes was just one to two cuts.  The fact that the Fed has already reduced rates once starts the cutting cycle and feeds potential gains in cyclical and rate-sensitive stocks. This includes small caps and sectors such as energy, industrials, materials, and utilities.

The election may have a muted impact on the broad stock market, as the policies of both parties and candidates are well known.  However, there are sectors that can be impacted by the election’s results. A Democratic win might mean higher taxes and stricter regulation, which favors large caps, global companies, and tech stocks. A Republican win likely means lower taxes and less regulation, which can benefit domestic companies, small caps, cyclicals, energy, and industrials.

Small caps have substantially underperformed in recent years, partly due to posting lower earnings growth than large-cap stocks and their greater exposure to variable-rate debt burdens. The market’s surprise could be a resurgent small-cap sector, especially if Trump wins and the Fed continues to ease interest rate policy.

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