Market Recap: Q3 2024 – Small Caps Surge Amid Rate Cuts

As we conclude Q3 2024, North American equity markets posted impressive gains, with a notable shift towards small-cap stocks. The TSX Composite led major indices with a surge of 9.23%, while the TSX Small Cap index posted a robust gain of 6.79%. In the U.S., the S&P 500 rose 4.73%, lagging its smaller counterpart, the S&P 600, which rallied strongly with a 9.19% increase.

This quarter’s standout story was the significant outperformance of small-cap stocks in the U.S. market. Importantly, the bulk of the S&P 600’s impressive gain occurred before the Federal Reserve’s rate cut. This performance was driven by a rotation out of large-cap stocks into small-caps, primarily due to a longstanding valuation gap that had made smaller companies increasingly attractive to investors. This shift underscores the importance of valuation in driving market movements, as investors sought opportunities in previously overlooked areas of the market.

While the small-cap rotation was already underway, central bank actions provided additional support to the broader market. The Bank of Canada implemented two 0.25% rate cuts, bringing the benchmark rate from 4.75% to 4.25%. The U.S. Federal Reserve enacted a 0.50% rate cut, lowering the benchmark rate from 5.5% to 5.0%. These rate cuts, while coming after the initial small-cap surge, helped sustain the positive momentum across markets and likely contributed to the strong performance of the TSX Composite.

Looking ahead, several key considerations emerge. The strong performance of small-caps has narrowed the valuation gap with large-caps, however, the gap remains very large suggesting that more room for small-cap outperformance. The TSX Composite’s leading performance suggests strong confidence in Canada’s economic outlook, potentially supported by the narrower gap between Canadian and U.S. interest rates. With both central banks now in easing mode, markets will be watching for signals of further rate cuts and their potential impact on different market segments.

The rotation into small-caps and declining interest rates may lead to shifts in sector leadership, with value-oriented and interest-rate-sensitive sectors potentially seeing increased interest. The broadening of market performance to include small-caps is generally a positive sign for overall market health, but sustainability will be key.

As we enter the final quarter of 2024, these trends underscore the importance of maintaining a diversified portfolio that can benefit from opportunities across various market capitalizations and geographies. The quick rotation we witnessed this quarter highlights the need for vigilance and flexibility in investment strategies. We continue to review your asset allocations in light of these significant market moves, considering both the valuation-driven shifts and the impact of monetary policy changes. As always, we’re here to help you navigate these dynamic market conditions and align your investments with your long-term financial goals.