"Interest rate cut trade" and "Trump trade" continue to dominate: Small-cap stoc

Following the cooling of the U.S. CPI last Thursday, rate cut trades have become prevalent, and the style of U.S. stocks has begun to shift. Even investors' appetites have changed after Trump was attacked, with assets like Bitcoin and gold also rising.

Analysts have pointed out that this is the result of the combined impact of the "Trump trade" and the "rate cut trade."

On Tuesday, the small-cap index Russell 2000 continued to surge by 3.5%, while the Nasdaq index only rose by 0.2%. The recent shift in U.S. stock style is very obvious: there is a preference for small-cap stocks over large-cap stocks.

Moreover, Bitcoin has also maintained its upward momentum and returned above $65,000.

Even gold hit a historical high on Tuesday, with spot gold closing at $2,468 per ounce, with a year-to-date increase of 19.68%.

Why are small-cap stocks, Bitcoin, and gold rising?

Huatai Securities indicated that when the "Trump trade" and the "rate cut trade" both strengthen, presenting a "strong resonance," assets such as small-cap stocks, Bitcoin, and gold may become favored, and the U.S. Treasury yield curve will also become steeper.

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The team led by Zhang Jiqiang at Huatai Securities pointed out that the U.S. June CPI inflation data fell more than expected, coupled with Powell's dovish remarks, which boosted expectations for the Federal Reserve to make the first rate cut of the year in September. After the first presidential debate and the shooting incident, Trump's poll support advantage has expanded, and the U.S. is expected to enter the "Trump 2.0" era. Under the alternating dominance of the "rate cut trade" and the "Trump trade," U.S. stocks rebounded with volatility, the U.S. Treasury yield curve became steeper, the dollar's trend weakened, gold and Bitcoin were supported, and emerging market currencies welcomed a turning point.

Based on the relationship between U.S. Treasury rates and rate cut expectations, CICC also expects that U.S. Treasury rates may fluctuate in the range of 4.2% to 4.7% in the short term, which basically corresponds to the expectation of three rate cuts within the year and no rate cuts within the year. After the rate cut is realized, the rate may fall below 4% due to trading factors, and then gradually rebound due to expectations of good growth, gradually turning to assets that benefit from reflation, such as bulk commodities like copper and oil, and cyclical sectors of U.S. stocks.

Similar to U.S. Treasuries, gold is also the case. CICC pointed out that assuming a real interest rate of 1~1.5% and the dollar at 102~106, gold is expected to reach the milestone of $2,500 per ounce within the year.Two major factors are contributing to the sharp rebound in small-cap stocks: short covering and the beginning of an improvement in the earnings outlook for these stocks.

So far this year, traders have set a record for net short positions in small-cap stocks since 2023.

According to data from S3 Partners, about 25% of the $68 billion iShares Russell 2000 ETF is shorted, compared to 9.9% for the $56.4 billion SPDR S&P 500 ETF Trust, and 7.6% for the $30.2 billion Invesco QQQ Trust Series 1.

Cole Wilcox, CEO of Longboard Asset Management, noted: "Hedge funds and traders held a record short position in small-cap stocks ahead of last week's CPI report, only to be caught off guard by the lower-than-expected inflation rate, triggering a fierce rebound in these stocks."

Moreover, the earnings outlook for small-cap stocks is also starting to improve, attracting more investors. According to an analysis by RBC Capital Markets, revenue and net profit growth forecasts for the Russell 2000 Index indicate that the index will rebound strongly by the end of 2024, approaching the S&P 500 Index. Strategists led by Lori Calvasina found that the upward revision rate of earnings expectations for the Russell 2000 Index is also beginning to align with that of the S&P Index.

Eric Sterner, Chief Investment Officer at Apollon Wealth Management, also pointed out: "More attractive valuations could help trigger a strong rebound in small-cap stocks, especially as the Federal Reserve is expected to lower interest rates."