Small Cap Tailwinds

• On Tuesday, the S&P 500 gained 0.6%, and the Dow Jones surged 742 points, extending its record close for the second consecutive day with its strongest performance since June 2023.

• The Nasdaq 100 edged higher by 0.2% as investors shifted from large-cap to small-cap stocks.

• Industrial stocks led the day's gains, propelling the Dow to an all-time high, with Caterpillar and Boeing soaring 4.3% and 3.8%, respectively.

• In earnings news, UnitedHealth surged 6.5% after reporting better-than-expected results, also bolstering the Dow.

• Bank of America climbed 5.3% on earnings and revenue beats.

Back in December of last year, we looked at this chart of the Fed's New Financial Conditions Index.

Remember, this index is designed to incorporate the lags of monetary policy, and project (in this case) one-year forward what the impact will be on real GDP growth.

If the line is above zero, financial conditions are expected to be a drag on growth (restrictive policy). If it's below zero, financial conditions are expected to be a boost to growth (stimulative policy).

Also remember, each of the periods in the chart that shared the characteristic of "historically tight levels" (i.e. the peaks on the chart) were soon followed with some form of Fed easing (either rate cuts, QE, or in the case of 2015-2016 - walking back on projected rate hikes).

As you can see to the far right of the chart, one of those peaks was last October - that's when Jerome Powell signalled the end of the tightening cycle, and the Fed started telegraphing the easing cycle.

With that, back in that December 5th note “Fed's New Financial Conditions Index” ( here ), we also discussed the performance of stocks following each of the turning points in the chart (the peaks). Stocks did very well in the subsequent 12-month period - and small caps outperformed.

Let's revisit that analysis and take an updated look at small cap performance since that October peak/turning point in the chart above.

So, the Russell 2000 (small cap stocks) is now up 39% since the Fed's pivot to a dovish stance on rates back in October - running right around the average return for small caps after these turning points.

And we've had about 10 percentage points of that performance just since the CPI report last Thursday. But as you can see in this longer term chart for small caps, we remain about 4% away from the all-time highs.

And the tailwinds are just forming . . . If you’re looking for a starting point, the table below, from Gryning AI, shows the best Small Cap ETF’s to Buy.