After the Fed rate cut, who will be the big winner in the stock market?

According to Goldman Sachs, a sector of US stocks may experience rapid growth after the Federal Reserve cuts interest rates: mid-cap stocks, which are stocks with market capitalization between small-cap and large-cap stocks.

Goldman Sachs analysts stated that compared to large-cap and small-cap stocks, mid-cap stocks have historically shown stronger growth within a year after a Fed rate cut.

In a report on Tuesday, the analysts wrote, "Since 1984, the S&P 400 mid-cap index has typically outperformed the S&P 500 index and the Russell 2000 index in the 3-month and 12-month periods following the first Fed rate cut."

They forecast a return rate of 13% for mid-cap stocks next year, mainly due to lower initial valuations and a healthy growth environment.

The analysts stated, "Historically, lower initial valuations have been an important indicator for predicting future returns of mid-cap stocks, especially at extreme levels, unless the US economy enters a recession."

They added that compared to large-cap stocks, mid-cap stocks "offer growth and quality at a discount," while large-cap stocks are currently trading slightly below the historical highs set during the tech bubble and the post-COVID-19 prosperity period.

The analysts mentioned that the market generally predicts an average growth rate of 11% for mid-cap stocks over the next two years, while the annual growth rate of the S&P 500 index is 7%.

On the other hand, compared to small-cap stocks, mid-cap stocks have better balance sheets and profitability. "Small-cap stocks are even more sensitive to the economy than mid-cap stocks," the analysts said, adding, "The risk of a return of close to 4% in the 10-year US Treasury yield and renewed growth concerns suggests that small-cap stocks may struggle to outperform large-cap stocks sustainably."

Goldman Sachs analysts stated that their expectations for mid-cap stock performance largely depend on strong, accelerating economic growth, which would lead to the strongest monthly returns for mid-cap stocks.

The analysts said, "As long as the US economy is expanding, the S&P 400 index typically generates positive returns. When the economy is expanding and accelerating (+2%), the median monthly return for mid-cap stocks is the strongest, but when the expansion slows down (+1%, which is Goldman's baseline forecast), the median monthly return for mid-cap stocks remains robust."

They pointed out that further soft labor data following the unexpected rise in the US unemployment rate in July could bring downside risks to mid-cap stocks, as the industrial and financial sectors account for a significant portion of the index.

However, the analysts stated that these risks "should be cushioned by the relatively lower valuations of mid-cap stocks compared to large-cap stocks and their strong fundamentals relative to small-cap stocks," and the likelihood of an economic recession next year is low.

Goldman Sachs expects the Federal Reserve to cut interest rates by 25 basis points at the policy meeting next week, followed by 25 basis points cuts in November and December.

This forecast is slightly conservative compared to the market's general consensus. Investors expect a 25 basis points rate cut by the Fed in September and a total of 100 basis points cut by the end of this year.

The analysts stated, "In the short term, the performance of mid-cap stocks relative to large-cap and small-cap stocks will depend on the strength of economic growth data and the trajectory of the Fed's easing cycle."