2 Small-Cap Stocks I Expect to Shine as the Fed Starts a Rate-Cutting Cycle
A better environment for and predicted sector rotation into small-caps should benefit both these names.
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Well, investors will finally get their much hoped for and anticipated cut to the Fed Funds rate Wednesday. It will be the first rate reduction since 2020 and follow one of the more aggressive monetary tightening programs since the days of Paul Volcker.
The only real question will be whether Fed Chair Powell and company will opt for a rate cut of 25 or 50 basis points and what commentary will follow this action. I mentioned in my column on Monday that gold tends to do well in environments where interest rates are falling, given the yellow metal is a non-yielding asset.
Earlier this week, the chief market technician at BTIG came out stating that small-cap stocks can offer a better risk/reward in the near-term than large-caps. He believes this is especially the case should the Fed lower rates by 50 bps Wednesday.
This makes to me sense as small-caps largely don’t have the cash hoards of their larger brethren, tend to have less financial flexibility and many of them carry significant debt loads. In addition, eventually, there has to be some sector rotation in the market, one would think. The small-cap benchmark, the Russell 2000 Index, has returned less than half that of the S&P 500 over the past five years and has had less than one-third of the returns of the Nasdaq.
If rate cuts do spur a rotation into small-cap stocks, there are two names I still like in what I consider an overbought market. A better environment for small-caps should help both of these names.
Small-Cap #1
Let’s start with Viridian Therapeutics VRDN, whose stock has been on a nice roll so far in September. Last week, the Massachusetts-based company announced encouraging trial data around its lead drug candidate that is being evaluated to treat active Thyroid Eye Disease, or TED. Results easily met the study’s primarily endpoint, which bodes well for another trial where the drug is being evaluated to treat chronic TED. Those results should be out before the end of 2024.
I expect Viridian to file Biologic License Applications for both indications in the second half of 2025. The company also has a more promising candidate targeting these ocular diseases that is just kicking off pivotal studies. Meanwhile, management took advantage of last week’s positive trial news to address its near- and medium-term funding needs via a secondary offering. I expect this small-cap stock to continue to climb.
Small-Cap #2
Dave & Buster's Entertainment PLAY is one of the few consumer-focused stocks I currently own in my portfolio. And I only started to accumulate the shares after they had fallen more than 40% from their recent highs this spring. A leader in "Eatertainment," the company has struggled thanks to the challenges low- and middle-income consumers are facing right now.
Dave & Busters did report decent Q2 results last week. A new management team is making numerous changes to make both operations and marketing processes much more effective and efficient. This should result in a significant increase in EBITDA in the coming years, in our view.
The company is also looking to expand its franchise internationally and it kicks off a significant amount of operational cash flow. The shares are not expensive, trading at 11 times trailing earnings.
At the time of publication, Jensen was long PLAY and VRDN.
