Markets on Edge: Powell's Speech and the Future of Small-Cap Stocks

This week's sell-off in high-flying growth stocks may signal market jitters ahead of Federal Reserve Chairman Jerome Powell's speech at Jackson Hole. But another area of the stock market could see major volatility after the Fed Chair speaks Friday: small-cap stocks.

Potential Impact on the Russell 2000

Bank of America analysts wrote this week that small-cap stocks are likely to experience large moves in either direction after Powell comments on the path of monetary policy. Jill Carey Hall, an analyst at the bank, noted that the speech could prove to be an important near-term catalyst for the Russell 2000 index, which tracks small-cap stocks.

"A dovish speech could spur a rally, while a more hawkish speech could trigger short-term downside as the market adjusts rate cut pricing," she said.

Monetary Policy and the Fate of Small Caps

Powell's speech is expected to set the tone for monetary policy for the remainder of the year. Market consensus largely anticipates that a dovish nod towards rate cuts in September and beyond would be a bullish driver for stocks. However, following a mixed bag of recent economic data, some doubt remains about the Fed Chair’s stance.

Small Caps in Times of Recession

Historically, small-cap stocks have outperformed large-cap stocks in rate-cutting cycles nearing recessionary periods. However, their performance is more mixed during non-recessionary times. The question now is: Is the US economy heading towards a recession?

Diverging Views on Recession

While some believe the U.S. economy will avoid a recession in 2025, others believe that the possibility of a recession still exists.

The Bottom Line: A State of Uncertainty

As the market braces for Powell's speech, uncertainty remains high, particularly regarding whether he will signal a shift towards a more dovish policy stance. But one thing is certain: the fate of small-cap companies largely hinges on this speech.

As Carey Hall added, "Given small caps’ increased rate sensitivity/higher refinancing risk, the boost from rate cuts may be more positive than historically in the absence of weakening macro data."