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  • Writer's pictureRealFacts Editorial Team

Elevated Rates Provide Small and Mid-Cap Investment Opportunities

Brent Schutte, Chief Investment Officer at Northwestern Mutual Wealth Management.

Brent Schutte, Chief Investment Officer at Northwestern Mutual Wealth Management, recently shared his insights during an interview on Bloomberg Markets: The Close regarding the implications of elevated interest rates and the "higher for longer" narrative on the economy and the stock market. Schutte highlighted that the average outstanding mortgage debt in the US economy stands at 3.8%, while the current rate is approximately 7.5%. He pointed out that many US consumers have yet to fully experience the effects of these rate cuts due to a time lag. Time lag refers to the delay between the occurrence of an event, such as the Federal Reserve cutting rates, and its measurable impact or consequence. Referring to the federal interest rate Schutte said, “The longer it stays elevated, the more it works its way to the economy and I think that eventually leads to a mild recession somewhere down the road.” If a mild recession occurs in the future, investors have several potential investment options to help them weather the downturn effectively.

In this scenario, Schutte finds small and mid-cap stocks attractive. These stocks are more susceptible to positive or negative economic conditions due to their reliance on debt financing compared to larger, cash-rich mega-cap stocks. Because of this heightened sensitivity to economic conditions, the market has already assigned somewhat discounted valuations to these smaller companies, anticipating the possibility of a recession rather than the no-landing scenario that many investors are hoping for. Schutte highlighted the irony that due to their already discounted valuations, small and mid-cap stocks are likely to experience less drawdown once the recession arrives. Conversely, they may perform significantly better on the opposite side of the economic cycle.

Given the potential strength of small and mid-cap stocks as investments during a recession, the question arises: When should investors aim to enter these discounted positions? Schutte suggested a possible entry point when he said, “I do think eventually the Fed will be able to or will have to cut rates fairly aggressively when that recession arrives. That could be the timing point for these names to start outperforming.” Additionally, he believes that timing the market precisely may be challenging. To avoid entering too late, he suggests capitalizing on the currently discounted valuations by beginning now to add these positions to portfolios gradually.

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