Fed rate cut chain reaction: Small-cap stocks highly favored

The once unpopular small-cap market has been in the limelight this month, driven by multiple factors such as low valuation, loose monetary policy, local favorable factors, and investors seeking risk diversification.

Recently, global small-cap markets have surged, with one of the main reasons being the expectation of a significant 50 basis point rate cut by the Federal Reserve next week, as small businesses rely more on borrowing and floating rate loans.

The surge in small-cap markets is particularly evident in Asia, with Thailand, Singapore, and New Zealand emerging as the best-performing markets globally this month. The benchmark indices in these markets have all risen by at least 3% this year, while the MSCI Global Stock Index has fallen by about 1% after four consecutive months of gains. Foreign investors are expected to increase their holdings of Southeast Asian stocks for the fifth consecutive week.

Even after the recent surge ends, the valuations of these Asian markets still have an advantage. The current price-to-earnings ratios of the benchmark indices in Thailand, Singapore, and the Philippines are all below 15 times and lower than their three-year averages. In comparison, the price-to-earnings ratio of the MSCI Global Index is over 17 times, while the S&P 500 Index and the India NSE Nifty 50 Index have price-to-earnings ratios of over 20 times.

Some small-cap markets outside Asia have also performed well this month, with Argentina, Lebanon, and Zambia's stock markets ranking among the best-performing markets globally.

Small-cap Markets Benefit from Multiple Tailwinds

As large-cap markets enter a period of adjustment, multiple favorable factors are driving attention to small-cap markets.

Many smaller Asian markets have fewer stocks in the AI sector, so valuations are not expensive. In addition, the dovish turn by the Federal Reserve has led to currency appreciation in these Asian countries, creating room for some central banks to cut interest rates and implement loose policies to support economic growth.

New Zealand unexpectedly cut interest rates last month, leading to a rise in the country's stock benchmark index; the Philippines also cut interest rates for the first time in nearly four years and hinted at further easing in the future; Indonesia and Thailand are expected to cut rates in the fourth quarter. James Cheo, Chief Investment Officer for Southeast Asia and India at HSBC, said:

"With US rates stabilizing or falling, this provides smaller economies with the space to adjust their policies - they no longer need to worry about massive capital outflows when the Fed tightens monetary policy."

At the same time, these smaller economies are also benefiting from local favorable factors, such as Thailand's political stability recovery and Singapore's Real Estate Investment Trusts (REITs) benefiting from global rate cuts.

On the other hand, large-cap markets are facing an adjustment period

Volatility in the US stock market is rising - traders are discussing the Fed's easing pace, the outcome of the US election, and whether the AI boom has peaked.

The Bank of Japan is preparing for another rate hike, and the strength of the yen has caused the Japanese stock market's record-breaking upward momentum to stall.

The Indian stock market is facing valuation concerns, having previously recorded the highest gains globally The stock markets of South Korea and Taiwan, dominated by technology stocks, both experienced outflows of foreign capital this month, as the prospects for AI-related stocks remain uncertain.

Therefore, Manish Bhargava, CEO of Singapore's Strait Investment Management, stated:

"Some investors are seeking to diversify away from larger stock markets with higher volatility, leading to inflows into smaller markets. Investors may be looking to reduce risks associated with major economies and profit from the growth potential of smaller markets in this way."

However, these smaller stock markets have limited scale and face certain restrictions in attracting long-term investors such as pension funds. In addition, if market risk preferences recover and the global AI boom reignites, the outstanding performance of these small markets may only be short-lived