Over the past week, investors have been busy looking for the best way to deal with the Federal Reserve's first interest rate cut since 2020.

Surprisingly, when asked which stocks might benefit the most in the future, several strategists said it's neither large-cap stocks nor small-cap stocks - both of which have dominated the market headlines in recent months. Instead, the often overlooked mid-cap stocks may be in the best position for a breakthrough.

Ryan Detrick of Carson Group said: "History shows that once the Federal Reserve truly starts cutting rates, mid-cap stocks tend to start significantly outperforming the market."

Detrick expects that in the next 12 months, small-cap and mid-cap stocks could rise up to 20%, far exceeding the performance of large-cap stocks. Since the end of June, small-cap index $Russell 2000 Index (.RUT.US)$ has already surged 10%, while $S&P 500 Index (.SPX.US)$ Only rose by 4.7%.

Goldman Sachs recently found in an analysis that in the 12 months following the first rate cut, mid-cap stocks usually outperform large-cap and small-cap stocks. With increasing confidence in a soft landing, investors are increasingly willing to look for investment options beyond large companies.

In a report to clients earlier this month, Jenny Ma from Goldman Sachs mentioned: "The start of a Fed rate cut cycle may be a potential source of new stock demand and boost investor risk appetite. In the short term, the performance of mid-cap stocks relative to other sectors will depend on the strength of economic growth data and the pace of the Fed's easing cycle."

The team believes that undervaluation and strong economic growth will be catalysts for future returns, and expects a 13% return in the S&P 400 Mid-Cap Index over the next 12 months.

"This is a market rotation driven by sentiment based on hopes of a soft landing, favorable to boosting the riskiest areas of the market," said Emily Roland, Co-Chief Investment Strategist at John Hancock Investment Management.

According to Jill Carey Hall from Bank of America, mid-cap stocks are "the best recent hedge tool."

Hall pointed out in a report to clients: "The recent performance guidance and revision trends of mid-cap stocks are better, they on average perform better than small-cap stocks in recession periods, and considering the sensitivity of small-cap stocks to interest rates and refinancing risks when the Fed cuts rates less than expected, they can serve as hedge tools."

Investors expect the Fed to cut rates by about 75 basis points by the end of this year, and predict that by mid-2025 the policy rate will fall between 3.00% and 3.25%, exceeding the Fed's own forecast.

However, for Wall Street, this is nothing new, as it had already predicted about six interest rate cuts in 2024 at the beginning of the year.

The slow pace of the Fed's interest rate cuts and ongoing recession concerns are key factors driving investors from favoring small-cap stocks to mid-cap stocks, as small-cap stocks often have weaker balance sheets and lower profitability.

Brian Jacobsen, Chief Economist at Annexus Wealth Management, stated that the small-cap stock market may become 'challenging before becoming more attractive,' and that 'concerns about slowing growth are likely to outweigh the benefits of low borrowing costs.'

Stuart Kevin from Citigroup's Special Treat is also cautious about the trade, pointing out that investors should 'handle this group very carefully.'

Kaiser warned: 'Even in the event of a soft landing, we believe there will still be a batch of data worse than expected, and when the data performs poorly, the market will trade a hard landing like in early August, where small-cap stocks will be at the center of the storm.'

Although Wall Street remains skeptical of small-cap stocks, there is no need to rush to completely negate this group. David Kostin from Goldman Sachs mentioned in a report to clients this week that positive employment reports could further enhance investors' interest in risk assets.

Kostin wrote: 'Positive employment data could prompt some investors to shift from expensive 'quality' stocks to less favored low-quality companies, as the market may be pricing in a significantly higher probability of deterioration in the labor market.'

Editor/Rocky