Shifting Into "Rates Down"
Six Names Across Banking and Real Estate Poised to Benefit from Rate Cuts
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The Case for Small Caps
Banking
Real Estate
Final Thoughts
The Case for Small Caps
As the curtains close on Chair Powell’s “There is no 2% inflation target” Jackson Hole speech and Fintwit’s very own Bill Pulte investigates the things that really matter, like “Are Crayons erasable?” and “Did Lisa Cook really commit mortgage fraud?” one thing is clear: “Small Cap Summer” is blossoming into a surprising “Rate Cut Fall”.
The Federal Funds Futures market seems assured of a September rate cut (88%), and in fact implies more than 5 cuts will happen by next September. If this gets you thinking “wow more cheap cash to buy Nvidia”, this post isn’t for you (although history indicates you’re probably right anyways).
The impending rate-cut backdrop gets me interested in Small Caps, in particular inrate-sensitive names that found themselves in the wrong place at the wrong time in 2022 and have been left-for-dead ever since. Many of these names (especially within Real Estate and Banking) have been working tirelessly to improve efficiency and optimize their balance sheets, to minimal attention.
The backdrop for Small Cap outperformance is already materializing. For the first time since 2020, the Russell 2000 is projected to marginally outpace the S&P 500’s and Nasdaq 100’s earnings growth this year, and the picture gets even rosier in 2026.
The fun isn’t constrained to Small Caps. The S&P 400 Mid Cap Index is projected to put up its strongest EPS growth since 2021 next year. Despite the improving fundamental backdrop, a “rate cut” boost from Powell’s Jackson Hole Speech, and the most impressive relative Small Cap performance last week year-to-date (the Russell is now just 3% behind the S&P 500), Small and Mid Caps continue to trade at the largest discount to Large Caps since COVID.
How could this be? The truth is most people just don’t care. The proof is in the flows.
Despite the slight reversal last week, flagship Small Cap funds continue to bleed assets at a record annual pace. Money continues to flow into the S&P 500 and Nasdaq 100 as more and more Small Cap finally hang up their hats.
But where one man (or pretty much the entire market at this point) sees trash, another sees treasure.
I think the earnings, rate cut, and rotational backdrop for Small Caps is favorable and I am especially interested in comeback stories that are rate sensitive and are poised to gain from dovish Fed Policy.
When trading Small Caps, half the equation isn’t just how you trade, but rather what you trade. Knowing which names are especially exposed to certain factors is paramount, and establishing baskets like Tariff Slime or Government Efficiency or Mortgages leaves you prepared to spring into action in either direction, while others are cobbling together L/S pairs or baskets at the last minute.
I think it’s time to prepare a comeback basket for rate sensitive Small Caps. Here are 5 inflecting rate cut beneficiaries I am looking at across Banks, Mortgage Origination, and Real Estate, as well as a 7.60% REIT Preferred that has caught me eye.