On Wednesday in US Eastern Time, for the first time since 2020, the Federal Reserve announced a surprise interest rate cut of 50 basis points. As a result, small cap stocks in the US soared to their highest level in over a month. The small cap stock benchmark - $Russell 2000 Index (.RUT.US)$ briefly rose 2.4% to 2,259.70 points, although the gains later narrowed to just 0.2%. However, it was significantly stronger than the collective decline of the three major US stock indexes -$Dow Jones Industrial Average (.DJI.US)$,$Nasdaq Composite Index (.IXIC.US)$and $S&P 500 Index (.SPX.US)$On Wednesday Eastern Time, all three major US stock indexes closed with a downward trend.$Russell 2000 Index (.RUT.US)$It hit the highest level since August 1st in the regular trading hours of the US stock market, and is expected to continue to benefit from the rate cut cycle in the future.

Typically, small cap stocks tend to outperform large cap stocks in the short to medium term when the Federal Reserve announces the start of an interest rate cutting cycle because small companies are more sensitive to floating interest rates due to their smaller balance sheet and limited operating scale. The S&P 500 Index, a benchmark for large cap stocks in the US stock market, initially reached a new historical high of 5689.75 points, but narrowed its gains after Powell's speech, which had a dovish and hawkish tone, and ended with a decline of about 0.3%.

"We've had a good start to this (rate cutting cycle), which is a sign of our increased confidence in our policies." Federal Reserve Chairman Jerome Powell said at a press conference after the Fed's interest rate decision on Wednesday. Powell also noted that the main purpose of this substantial interest rate cut is to stabilize the US labor market and emphasized, "We are confident in the current adjustment of monetary policy, believing that this appropriate readjustment will help maintain a strong labor market, achieve moderate economic growth, and bring inflation back down to 2%."

Powell also pointed out at the press conference that the decision to cut interest rates by 50 basis points does not mean that the policymakers at the Federal Reserve expect the US economy to enter a recession. He stated, "There are currently no signs of increasing recession risks. Our policy adjustments are primarily meant to recalibrate in response to the current economic conditions."

Powell concluded that the Federal Reserve's monetary policy will be adjusted based on the future development of the economy, whether it is speeding up, slowing down, or pausing the easing policy, it will depend on the economic conditions. He stated that the future path of interest rate cuts will depend on changes in the labor market and inflation, but for now, the US economy is still strong.

The unexpected announcement of a 50 basis point interest rate cut by the Federal Reserve, as well as Powell's confident speech on the "soft landing" of the US economy, means that the interest rate cutting cycle of the Federal Reserve officially started in September and the US economy remains resilient. This is a major positive for small cap stocks in the US stock market, which have been suppressed since the Federal Reserve's rate hike cycle in 2022.

BTIG's Chief Market Technician Jonathan Krinsky believes that small-cap stocks in the US stock market can offer a better risk/reward profile than large-cap stocks in the short term. Krinsky previously pointed out in a report: 'If the market's expectation of a 50 basis point rate cut by the Federal Reserve is confirmed, the rise in small-cap stocks should accelerate.'

Lori Calvasina, Global Equity Strategist at RBC Capital Markets, recently stated that money flowing into small-cap stocks in the US stock market has not stopped even as funds continue to flow out of large-cap stocks. This indicates that more and more investors are interested in switching their funds to the small-cap sector.

As the Federal Reserve begins its interest rate cut cycle, the investment style shift from 'big' to 'small' in the market becomes more evident.

The seven technology giants in the USA with high weighting in the S&P 500 index, known as the "Magnificent 7", include: Apple,$Microsoft (MSFT.US)$and$Alphabet-A (GOOGL.US)$N/A.$Tesla (TSLA.US)$,$NVIDIA (NVDA.US)$,$Amazon (AMZN.US)$and $Meta Platforms (META.US)$It is the core driving force behind the continuous new highs of the S&P 500 index. Global investors have flocked to the seven technology giants throughout 2023 and the first half of 2024, betting on the frenzy of the growing AI trend in global companies. Due to the large market size and financial strength of technology giants such as Apple and Google, they are in the best position to leverage artificial intelligence technology to expand their revenue.

Looking at the entire US stock market, the core logic behind the comprehensive outperformance of the seven technology giants compared to value-based large-cap stocks and widely held mid-small cap stocks since 2023 is the global AI trend, as well as the fluctuating and occasionally receding expectations of rate cuts by the US Federal Reserve. The US economic growth trend is not too strong, nor is it weak enough to fall into a recession.

In such a trading situation, the seven major tech giants have become a "safe haven" for global funds in the face of uncertain interest rate expectations and slowing economic growth, thanks to their unparalleled AI revenue scale, solid fundamentals, incredibly strong free cash flow reserves, and expanding share buyback programs.

If the Federal Reserve officially starts its interest rate cut cycle and the US economy remains resilient without falling into a recession, there is a high probability that the upward trend in US stocks will rotate to small-cap stocks that have suffered long-term price declines since 2022. These stocks are highly sensitive to interest rate expectations, and even a slight rate cut is expected to increase their share price and valuation.

Some Wall Street strategists believe that under the macro backdrop of the Fed opening its rate cut cycle, the performance of small-cap stocks may far exceed that of the seven major tech giants and large-cap stocks. This is primarily because small-cap stocks are often highly sensitive to the benchmark interest rates set by the Fed and rely heavily on variable rate loans. Therefore, in the context of the Fed's rate cuts, the long-standing pressure on their debt side is significantly reduced, which is expected to improve profit margins and stock valuations.

Therefore, with the interest rate futures market already pricing in a 100 basis point rate cut by the Fed next year, the classic rotation trend of small-cap stocks or the profit recovery trend of small-cap stocks may completely emerge. This will drive funds to shift to some small-cap stocks that benefit from the rate cut cycle and have very cheap stock prices and valuations, rather than those tech giants with historically high valuations. Investors will become 'comparison shoppers' in the broadest sense, known as 'shopping around for the best deal'.

Editor/Rocky