Impact of no Fed rate cuts: Growth stocks, small-caps at risk

As markets weigh economic data to gauge whether the Federal Reserve will proceed with rate cuts in 2024, Envestnet PMC Co-CIO Dana D'Auria joins Yahoo Finance Live to share why she believes rate cuts may not materialize this year.

D'Auria notes that markets are grappling with "the fact that there's probably not going to be a rate cut as quickly as they hoped." She points out that the initial expectations of six rate cuts at the beginning of the year "didn't really make sense" given the market conditions at the time. D'Auria emphasizes that little has changed in the current market landscape, which she says has "plateaued." With no compelling data to support a rate cut, D'Auria questions, "why would the Fed be cutting rates anytime soon?"

Addressing the potential implications of a no-rate-cut scenario, D'Auria explains that growth stocks and small-cap stocks could be impacted. However, she acknowledges that "markets price things in very fast," suggesting that small-caps could potentially perform well, although only time will tell.

For more expert insight and the latest market action, click here to watch this full episode of Yahoo Finance Live.

Editor's note: This article was written by Angel Smith

Video Transcript

SEANA SMITH: Our guest here, we have Dana D'Auria, Envestnet PMC co-chief investment officer here joining us. Dana, let's talk about the positioning, how investors should be getting ready for the big meeting at the Fed next week. What do you make first of the wild trading day or the wild action that we saw in the bond market yesterday and how that sets us up?

DANA D'AURIA: Well, I do think that the market is contending with the fact that there's probably not going to be a rate cut as quickly as they hoped. And it's kind of odd, right? From the start of the year, I mean, we look back just a couple of months ago, six odd rate cuts being priced in and the expectation really didn't make sense with the rest of what was going on with the market, right?

You had the Fed at that point saying, hey, higher for longer. You had no sign of a recession coming and you had unemployment staying strong. And really what's happened is not a lot has changed and the market now is, sort of, coming to terms, right?

So we have inflation to your point, you know, ticking up a little bit, PPI. Core consumer inflation still kind of not getting under wraps in the way that the Fed would like. I mean, it's not going up in obviously any kind of extreme way, but it suggests that it's not also coming down. It's plateaued a bit and kind of staying stickier than wanted.

And then, of course, you know, unemployment rate ticked up a little bit, but initial jobless claims very low, relatively speaking. And you know, so it looks like the employment market is strong, consumer is strong. Why would the Fed be cutting rates anytime soon? So I know we've heard some dovish things coming out of the Fed and they're maybe are going to speak that way about it a little bit. But I think the market is recognizing, hey, look, we just might not get even three this year.

BRAD SMITH: Dana, what are the top pillars to the no-cut playbook for investors?

DANA D'AURIA: I think in terms of how you're thinking about it, and I'm a little-- so obviously, typically speaking, if you're not going to get rate cuts, then that should theoretically hurt growth stocks because they have longer dated cash flows, they have the discount backed by a higher rate. What we've seen is that technology, these big growth companies have not flinched, you know, one iota based on what's going on with interest rate expectations. And that's largely because they're self-funding, right? They have the cash. They don't need to go back to capital markets.

Where we've seen the pain kind of felt is small cap arena, which is more interest-rate sensitive. And so you'd think the intelligence on that would be, OK, seems like then we should stick with large caps. But remember that the market prices things in very fast, right? And so as it's looking at what the potential for rate hikes is throughout the course of the rest of the year, I think you take that longer term look, you look at valuations.

I'm still a proponent that at least some small cap position, maybe even a little bit of a tilt relative to the fact that, look, you've got a massive amount of mega cap in your portfolio. I don't care if you're passive, you're active. Unless they're taking massive tracking error, you've got a lot of mega cap. I still think there's a place for small, I think it just may be a bet you have to ride out a little bit longer.

SEANA SMITH: Dana, you mentioned the fact that we might not get three cuts now between now and year end. What's your base case? And when you talk about the impact it's going to have on equities, what more specifically then does that downside look like?

DANA D'AURIA: Well, you know, you're thinking about what has the market been thinking about in terms of why these high-- why the expectation of rate cuts to begin with, right? And what were the reasons potentially that would even rationalize that? Maybe one is that our federal debt is increasing so dramatically.

And perhaps there was an expectation that the Fed would want to lower the interest rate costs. I think that's still in the mix. Politics are still in the mix.

So I'm arguing a little bit, you know, yes, there's some reasons to still think that as long as the Fed feels comfortable that inflation doesn't tick back up, we could see a few more rate cuts. With that whole big thing being a caveat, I would say I think two to three. I actually lean towards the lower end is the base case, though, for all the reasons we've talked about.