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Where Small Cap Stocks Stand Amidst Rising Inflation

Current levels of inflation may have you wondering what investment choices you should be making, with year-over-year prices rising by 6.2% -- the highest since 1990, according to Forbes. Generally, inflation indicates a strong economy and leads to outperformance in the stock market. Since small cap stocks have a reputation for performing well when the promise of growth is high, it would seem as though they wouldn’t be too negatively affected by inflation. However, analysts have some concerns as global inflation rises.

“The current confusing, inflationary environment is causing a major stock market rotation into quality stocks that are characterized by strong sales and earnings momentum. The stock market is now shifting its attention back to fundamentally superior stocks,” says Nasdaq strategist Louis Navellier.

Small cap stocks have higher volatility, and therefore can be pretty fragile during times of economic instability. Anthony Chan, former chief economist at JPMorgan Chase & Co., says that “if interest rates fall because the Federal Reserve decreases rates due to an impending economic slowdown, small caps tend to underperform. However, after interest rates hit bottom and economic tailwinds turn positive, the outlook for small caps improves.”

What will truly determine the outcome in small cap performance amidst this period of inflation, Chan says, is a coinciding growth in the economy. While small cap companies are better protected from global developments, the effects of inflation on domestic companies (which primarily comprise the small cap market) could be a concern. That being said, a diversified portfolio should protect you from major losses. You can read more about the benefits of diversification in investments here.


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