Small caps soar, but investor cashflow heads for the exits

With a strong September comes an unexpected small-cap streak: The small-cap Russell 2000 has climbed to an all-time high after its longest run of weekly gains in nearly five years, boosted by US Federal Reserve rate cuts and a resilient US economy, Bloomberg reports. The small-cap index — which is historically seen as a “risky corner” of the US stock market — is outperforming as Wall Street unexpectedly recorded a positive September. Typically a negative month for equities, all three major US indices closed September in the green, marking their best September in 15 years.

Record outflows from iShares Russell 2000 ETF: Despite the rally, the iShares Russell 2000 ETF has seen USD 5.4 bn in outflows this year, putting it on track for its largest-ever annual withdrawal. While September inflows signaled some optimism, they were not enough to reverse the broader drawdown.

Not all small-cap indexes are keeping pace: The Russell’s breakout was not matched by higher-quality benchmarks like the S&P Small Cap 600, which excludes weaker firms, Ned Davis Research noted.

Lower borrowing costs boost appeal: Small caps typically do well in a strong economy with low interest rates, as many need to borrow to fund their operations. With the Federal Reserve now lowering rates and the economy on track for over 3% growth, investor confidence is tentatively returning, leading to positive fund inflows in September.

However, confidence has been eroded by repeated setbacks: Small caps have lagged behind large peers since the pandemic, struggling in 2022’s bear market and missing out on much of the AI-fueled rally that lifted the Nasdaq 100 by 50%. The Russell 2000 needed four years to reclaim a record high, underscoring the gap with tech-heavy indexes. Years of “false dawns” have left investors cautious, with many locking in gains quickly amid fears the rally won’t last, said Bloomberg Intelligence’s Athanasios Psarofagis.

Fundamentals still a headwind: Meanwhile, slow Fed rate cuts and weak earnings prospects for small companies continue to weigh on fundamentals, with Wells Fargo analysts suggesting the rally may already be “over,” while Sykon Capita’s Todd Stankiewicz argued that only a more supportive business environment will bring sustained inflows.

Long road to regain trust: It could take months, or a year, of consistent outperformance for small caps to regain investor trust, said Fulton Breakefield Broenniman’s Michael Bailey. For now, investor preference remains tilted toward large caps and high-risk alternatives like AI stocks or crypto ETFs until the business environment turns more favorable, Stankiewicz and Wells Fargo said.

MARKETS THIS MORNING-

It’s a positive morning so far for Asian markets, with South Korea’s Kospi leading the pack as Samsung Electronics and SK Hynix rallied in early trading. The two firms announced a partnership overnight with OpenAI to supply memory chips. Meanwhile, Japan’s Nikkei and Hong Kong’s Hang Seng Index are both in the green.

Meanwhile, Wall Street looks set to shrug off the government shutdown and extend its rally, with futures suggesting the S&P 500, Dow Jones, and Nasdaq will all open in the green later today as investors are expecting the shutdown to be short-lived.

THE CLOSING BELL-

The EGX30 rose 0.3% at yesterday’s close on turnover of EGP 5.1 bn (14.0% above the 90-day average). Regional investors were the sole net sellers. The index is up 23.6% YTD.

In the green: Ibnsina Pharma (+2.8%), Qalaa Holdings (+2.4%), and Rameda (+2.4%).

In the red: Misr Cement (-1.5%), Eastern Company (-1.4%), and Oriental Weavers (-0.9%).