Among small-cap stocks, Morgan Stanley also prefers growth over value (RTY)

Morgan Stanley’s U.S. equity strategists recommended that investors consider investing in small-cap growth stocks in light of likely interest rate cuts by the U.S. Federal Reserve.

The “differentiated relative assessment” of the strategists within the small caps (RTY) prefers long-term growth over Value stocks, said Katy Huberty, global head of research at Morgan Stanley, in a statement on Tuesday. Russell 2000 Small Cap Index (RTY)(IWM) recorded its fifth consecutive win on Tuesday and US Treasury yields (US10Y)(US2Y) continued their downward trend, supported by increased speculation that interest rate cuts will occur later this year.

“Longer-term small caps, which are growth-oriented and more sensitive to changes in their cost of capital, have benefited relatively from the lower returns, while more economically sensitive small caps (i.e. value) have not benefited,” Huberty said on the MS call.

The small-cap growth trade has higher relative upside potential due to earnings revisions, according to MS strategists. Huberty also said history shows that the small-cap growth cohort typically performs better when the Fed starts cutting rates. Biotech stocks are potential winners as this industry has the largest weight in the Russell 2000 Small-Cap Index (RTY). Biotech “has a strong relative track record after the Fed starts cutting rates,” she said.

A shift by investors out of the mega-cap technology stocks that dominate the S&P 500 (SP500)(SPY) and into small caps began last week after June consumer price inflation data showed further cooling toward the Fed’s 2% target. Traders are now pricing in the potential for at least two rate cuts, reviving a market theme from earlier this year that involved multiple Fed rate cuts.

The Russell 2000 (RTY) rose 3.6% on Tuesday, for a year-to-date gain of +11%. The Russell 2000 Value Index is up 8.6% and the Russell 2000 Growth Index is up 14.9% this year. The S&P 500 (SP500)(SPY) is up nearly 19% for 2024.

Small cap ETFs include (IJR), (VBR), (SPSM) and (DFAS).