🎙️ Clearly Cooled

Well, we’re glad that’s over. The S&P 500 just tumbled 4.25% to its worst week since March 2023, and the Nasdaq just finished its worst week (-5.8%) in two years. Bitcoin and oil also fell sharply.

On a positive note: This month, The Investor’s Podcast Network, which powers this newsletter, is celebrating its 10th anniversary.

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— Matthew & Shawn

Here’s today’s rundown:

Today, we'll discuss the biggest stories in markets:

• U.S. adds fewer jobs than expected

• The emerging case for small caps

This, and more, in just 5 minutes to read.

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In The News

💼 August Jobs Report: U.S. Adds Fewer Jobs Than Expected

The Federal Reserve is more likely to begin a series of interest-rate reductions this month, especially if the labor market continues to weaken. 

Clearly cooled: On Friday, the August jobs report showed the U.S. economy added 142,000 jobs last month, less than expected. This rebound from the soft July data that prompted a market selloff is more evidence that the labor market is a far cry from what it was circa 2021. 

• The unemployment rate fell to 4.2%, as expected. Last month, it had risen to its highest level in about three years.
  

• Fed Reserve governor Christopher Waller said Friday’s jobs report further shows a labor market that has “clearly cooled,” adding: “Based on the evidence I see, I do not believe the economy is in a recession or necessarily headed for one.”

Here come the cuts: It’s increasingly expected that the Fed will go with a traditional quarter-point reduction at its Sept. 17-18 meeting. Yet Waller said that would just be the start, and it’s “likely that a series of reductions will be appropriate.” He even said cutting rates in larger, half-point increments could make sense should the labor market keep deteriorating. 

• “These decisions will be determined by new data,” he said Friday. “While I expect that these cuts will be done carefully as the economy and employment continue to grow, in the context of stable inflation, I stand ready to act promptly to support the economy as needed.”
  

• New York Federal Reserve President John Williams noted that the central bank can now lower rates to a “more neutral setting over time.” More urgency isn’t necessary, he said. “I feel like we’re well positioned” to maintain a stable labor market and low inflation, he added. 

Why it matters:

A month ago, weak July hiring rekindled fears of an economic slowdown. Now, unemployment claims are up again, job openings have fallen, and wage gains are few and far between. The recent string of cool economic figures has put the U.S. stock market—currently near record highs—into one of its more volatile periods in the past two years. 

Big-time report: This jobs report shows hiring below expectations (not good) and unemployment falling (good). Depending on next week's inflation data, we might see a quarter- or half-point rate cut in less than two weeks. 

• “This is the biggest jobs report in several years in terms of its importance for the Fed, and how much it corroborates [the weakness] we’ve seen in other more closely watched labor market data,” observed an economist at Wells Fargo.
  

• Added one economist: “It’s not a spectacularly good labor market. But if this was a steady state, that’d be fine. The problem is that there’s a fair amount of evidence that it’s not a steady state. Things are still cooling.”

Read more

More Headlines

💡 What investors are getting wrong about the VIX right now

💭 A new era of easy money dawns as Fed nears first rate cut since 2020

📉 JPMorgan top economist says the Fed should cut rates by a half point

🤯 The case for $1 million per share for Berkshire Hathaway Class A stock

🤖 OpenAI co-founder Sutskever's new safety-focused AI startup SSI raises $1 billion in opening months, already valued at $5 billion

🚨 Massachusetts regulators fine Morgan Stanley over First Republic insider sales

💰 Selena Gomez is a billionaire, thanks mostly to her beauty brand

🤔 The Growing Case for Small Cap Stocks

Do you own small caps? The group has been largely out of favor for years due to lagging performance, but times might be changing. 

Some investors are betting that interest-rate reductions and better economic conditions could boost small-cap stocks. These stocks are more sensitive to interest rates and the economy because they tend to have more debt and rely more on bank financing. 

• “Small-cap stocks, hurt by inflation and rising interest rates in the U.S., have underperformed and were ignored by many investors,” says Invesco’s head of factor and core equity ETF strategy. From Aug. 1, 2014, through Aug. 1, 2024, the Russell 2000 index of small stocks returned 8.91% annually compared with returns of 15% on the large-cap S&P 500. 

Big vs. small: This year, the S&P 500 has trounced small caps. But there’s growing optimism on Wall Street that small caps will shine soon, assuming the U.S. won’t fall into a recession and the Fed will begin a series of rate cuts. 

• One chief investment officer wrote, “According to Wall Street analysts’ earnings estimates, stocks on the S&P SmallCap 600 are expected to see a 22.1% rise in earnings in 2025 versus 14.8% for the S&P 500.”
  

• Investors have taken notice. Small-cap ETFs have seen $25.1 billion in inflows this year, about triple the $9.4 billion invested during the same period last year. 

Less liquid: To be sure, financial advisors and analysts caution that small caps are generally riskier for the average individual investor who is used to large-cap tech and broad-market ETFs that track the S&P 500. 

“Small-caps are more volatile than large-cap companies, and they are less liquid, so they can be expensive to trade on your own,” says one portfolio manager of a $1.9 billion small-cap value mutual fund. “They are not tracked as much as large companies by financial analysts and institutions, and the available research on these stocks is usually limited.” 

Why it matters:

After a wild run for the Magnificent Seven, many investors ask the eternal question: What will rally next?

Stocks like Nvidia, Apple, Microsoft, and Meta have huge market capitalizations, and they’re widely owned. Meanwhile, some investment strategists say small-caps are selling for historically low valuations. 

• By one measure, the forward 12-month price-to-earnings ratio, the S&P SmallCap 600 is 16.9, compared with 22 for the S&P 500.
  

• “Small-caps are cheap, so it’s a good time to buy,” says a managing principal, noting that the Mag Seven may not be able to carry the market again into next year. “But the bull run in these megacaps may not go on forever.”

Among the options: Many advisors tell their clients to consider buying low-cost ETFs that track a small-cap index rather than take on single-stock small-cap risk. For instance, the $2.9 billion Vanguard S&P Small-Cap 600 ETF (ticker: VIOO) has an expense ratio of just 0.1%. 

• “These offer a wide berth of small-cap stocks across industry sectors, so investors get broad equity diversification,” says a research analyst at Morningstar Research Services.
  

• For most investors, buying small-cap stocks is about taking a long-term view. Many small-cap companies need time to make substantial gains.
  

• “When evaluating a fund, look at the track record of the fund’s manager and the fund’s long-term performance,” another fund manager said. 

As always, we say this with the usual caveat: This isn’t investment advice. 

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Quick Poll

On Wednesday, we asked: What type of index fund do you prefer?

— About half of investors said they prefer to hold a broad-market index, such as those that track the S&P 500. “I like to hold a bunch of different indexes like the S&P 500, NASDAQ 100, MSCI EAFE, Emerging Markets, so I can just own the world!” one wrote.

— Another said, “I like VYM and VOO when dollar-cost averaging. 80% of all the money ever made on the stock market has been through boring, old dividends. VYM is still the best index fund, in my opinion.”

— Wrote another investor: “S&P 500 is popular, but QQQ should be the replacement because it has significantly out performed it with a similar volatility level.”

See you next time!

That's it for today on We Study Markets!

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