IWM and Fed Funds Rate
In Dec 2000, Jul 2007, and Jul 2019, the Fed cut rates, but IWM (small caps) fell 30–50% soon after:
| Cut Date | Fed Cycle | Market Context | IWM Performance |
|---|---|---|---|
| Dec 2000 | Dot-com bust → recession | Tech bubble bursting | ‒44% in 2001 |
| Jul 2007 | Pre-GFC → credit crisis | Housing market collapse brewing | ‒50% by early 2009 |
| Jul 2019 | “Insurance cuts” | COVID crisis 6 months later | ‒40% by Mar 2020 |
So why did IWM fall even after rate cuts?
Because in each case, the rate cuts were a reaction to deteriorating fundamentals, not a pre-emptive stimulus:
1. Dec 2000
- Fed cuts as dot-com valuations implode
- Earnings collapse, broad recession follows
- Small caps hit hard due to illiquidity, poor balance sheets
2. Jul 2007
- Early signs of credit tightening
- Subprime defaults already spiking
- Small caps fall with the broader financial contagion
3. Jul 2019
- Fed begins “insurance cuts” amid trade war + slowing global growth
- COVID shock wipes out liquidity six months later
Key Lesson:
Rate cuts don’t guarantee rallies.
They often come too late — after credit conditions have already deteriorated.
So why recommend IWM before rate cuts today?
Because the macro context today may be structurally different, and the trade depends on why the Fed is cutting, not just that it’s cutting.
When IWM does work well after cuts:
1. Soft Landing / Preemptive Easing
- If Fed cuts before a recession fully forms (early and aggressive easing), liquidity supports small caps.
- Example: mid-1990s rate cuts → soft landing → IWM outperforms
2. No Systemic Crisis
- IWM underperforms in crisis (credit events, bubbles bursting).
- If there’s no credit crunch or financial shock, rate cuts can spur capex, lending, and small biz growth.
3. Real Yields Decline
- If inflation is falling and real yields compress, risk premia narrows → IWM gets a bid.
Updated IWM Strategy: Risk-Aware Approach
| Scenario | Macro Setup | Action |
|---|---|---|
| Soft landing | Inflation declining, employment resilient | Gradually accumulate IWM 1–3 months before cut |
| Recession risk rising | Credit spreads widening, layoffs rising | Avoid IWM or hedge via puts |
| Crisis (e.g., credit event) | Financial system stress (e.g., SVB-like shock) | Stay in cash / defensives, re-enter IWM later |
| Fed panics late | Cuts only after damage is done | Wait for capitulation low post-cut, then buy |
Safer Alternatives to IWM
If you’re wary of the historical downside, consider:
- Quality small caps ETF (e.g., OUSM): Screen for profitable, dividend-paying small caps
- Mid caps (VO): Less volatile, still benefit from easing
- Large cap cyclicals: Industrials, banks, housing stocks (higher balance sheet quality)
Bottom Line
Not all rate cuts are bullish — especially when they come too late.
But if we’re in a soft landing or mid-cycle slowdown, and the Fed is easing proactively, small caps (like IWM) could rally strongly after an initial shakeout.
Invest Alpha 