Source: Broker China
Author: Chen Ming
Original title: “A surprise on Wall Street! Hedge funds are betting, Moody's issues a warning”
Huge debts are peaking, and US small-cap stocks have become the most dangerous stocks in the market?
According to data compiled by Bloomberg, companies in the small-cap Russell 2000 Index hold a total of $832 billion in debt, of which 75% ($624 billion) will need to be refunded before 2029.
Although small-cap stocks are currently as cheap as they have been in decades past, Wall Street is still not optimistic about this sector. According to Ned Davis Research, the hedge fund's net short position in Russell 2000 futures was the largest on record.
The riskiest stocks
According to a recent Bloomberg report, a debt wall of over 600 billion US dollars hangs over the most dangerous stocks in the market. According to data compiled by Bloomberg, companies in the small-cap Russell 2000 Index hold a total of $832 billion in debt, of which 75% ($624 billion) will need to be refunded before 2029. By contrast, companies in the S&P 500 index had only 50% of their debt due at that time.
Marija Veitmane, a Wall Street veteran and senior multi-asset strategist at State Street Global Markets, said, “Although the valuation is very attractive, we won't buy it yet. We don't like small-cap stocks because they are more sensitive to the economic slowdown, the cost of financing is higher, and profits may be more squeezed.”
Smaller companies, in particular, tend to have significant amounts of variable interest debt, usually in the form of loans because they are usually not big enough to borrow on the bond market. This means that soon after the Federal Reserve raises interest rates, their interest expenses tend to be set higher, and large companies with fixed-rate bond debt may wait longer before interest rates have a significant impact on their borrowing costs.
Also, the performance of small companies is usually related to the overall state of the economy. As a result, as changes in economic conditions and uncertainty become the subject of the current market, Wall Street professionals are skeptical about buying the riskiest stocks, even at apparently cheap valuations.
Guy Miller (Guy Miller), chief market strategist at Zurich Insurance Company, said: “There is a reason larger, higher quality companies cost more. They often don't have any problems with financing, and they don't rely too much on interest rate policies.”
Since this year,$Russell 2000 Index (.RUT.US)$It only rose 1.6% because the market's expectations for the Fed to cut interest rates have dropped from 6 times in January to 2 times, representing large US stocks$S&P 500 Index (.SPX.US)$It rose 9.5%. Since the beginning of 2023, the S&P 500 has risen by more than 36%, more than double the increase in the Russell 2000 index.
Where's the problem?
Beginning at the end of April, investors generally lacked confidence in the stock market's rebound, and flocked to the so-called “Magnificent Seven” tech giant. These tech giants were considered safer during times of economic uncertainty, causing the Bloomberg “Magnificent Seven” total return index to rise by about 9% over the past three weeks. In contrast, according to Ned Davis Research, the hedge fund's net short position in Russell 2000 futures was the largest on record.
Bloomberg pointed out that the problem with small-cap stocks now is interest rates and the direction of the economy, as inflation is still more enduring than expected at the beginning of the year.
Earnings don't help small cap stocks either. According to BI data, Russell's revenue for the first quarter of 2000 increased by only 0.3%, while the S&P 500 grew at a rate of 4%. A Bank of America analysis shows that even if interest rates remain at current levels, considering that nearly half of debt is short-term or floating interest rates, the operating income of small-cap stocks outside the financial sector may decrease by 32% over the next five years.
According to data compiled by Bloomberg, small-cap stocks are increasingly losing money. About 42% of companies in the Russell 2000 Index currently have negative profitability compared to less than 20% in the mid-1990s. Hugh Grives, fund manager of the Premier Miton US Opportunities' fund, said: “The quality of Russell's companies is clearly worse than 20 years ago. There are more companies that can go public, but they have never made a profit, and they may never be profitable.”
Analysts pointed out that if interest rates remain high for a longer period of time, it will be more detrimental to small-cap stocks because such companies have more debt and higher borrowing costs.
Moody's issues warning
Recently, a number of Federal Reserve officials have taken turns releasing signals, suggesting that the Federal Reserve is still not in a hurry to cut interest rates in the short term. This raised concerns from Moody's chief economist Mark Zandy. Zandy said that if the Federal Reserve does not cut interest rates in the next few months, there may be adverse consequences. Zandy warned that if the Federal Reserve keeps interest rates at current levels, it will increase the risk of a recession and may reveal other flaws in the financial system. He pointed out that due to the slow growth of loans due to rising borrowing costs, the credit situation in the US is being “eroded”, which may put pressure on banks' balance sheets.
Marija Veitmane, senior multi-asset strategist at State Street Global Markets, also said that if the Federal Reserve delays interest rate cuts, it will have a substantial adverse impact on the economy. Although the economy seems stable at present, continued high interest rates may cause more economic problems in the future. She predicted that without adjustments, the economy may not be able to achieve a smooth “landing”; on the contrary, it may “crash.”
The Federal Reserve announced at the monetary policy meeting that ended on May 1 that it will keep the federal funds rate target range unchanged between 5.25% and 5.5%. This is the sixth time since September last year that the Federal Reserve has kept interest rates unchanged.
Despite long-term downside risk warnings, the Federal Reserve is unlikely to relax monetary policy in the short term, as Fed officials remain cautious about the pace of inflation. The market generally expects the Federal Reserve to keep interest rates unchanged at the next policy meeting. According to CME's US Federal Reserve's observation tool, most investors expect to cut interest rates only once or twice this year. This forecast is far lower than the six rate cuts expected at the beginning of the year.
On May 8, local time, US Federal Reserve Bank of Boston Governor Susan Collins said that the Federal Reserve may keep the federal funds rate high for longer than expected to curb demand and reduce inflationary pressure. On May 10, US Federal Reserve Governor Michelle Bowman said that due to ongoing inflationary pressure, it is inappropriate for the Federal Reserve to cut interest rates during the year.
Editor/Somer