Small-cap stocks advanced amid a broad market rally on Thursday after the Federal Reserve lowered interest rates by half of a percentage point on Wednesday.

Small-cap stocks rallied on Thursday, riding the wave of a broad market upswing after the Federal Reserve initiated its much-anticipated rate-cut cycle with a substantial half-percentage point reduction. The small-cap Russell 2000 (RUT) index surged over 2% at the market open, though it pared back some gains, still up 1.5% by midday trading.

Small caps stand to benefit more from lower interest rates than their larger counterparts because they are more likely to hold floating-rate debt. Approximately one-third of Russell 2000 debt is floating-rate, compared to about a quarter for mid-cap S&P 400 companies and only 7% for the large-cap S&P 500, according to Goldman Sachs. Additionally, small-cap companies face a higher percentage of fixed-rate debt maturing within the next five years, which makes the Federal Reserve’s decision to launch its rate-cutting cycle with a 50 basis-point reduction highly impactful by significantly reducing refinancing risks.

Risks to Small-Cap Earnings Linger

However, Bank of America (BofA) analysts cautioned that lower rates alone might not give small-cap stocks an advantage over larger companies. September and October are historically challenging months for small caps, and this year’s political uncertainties and economic fragility add even more complexity. Elevated rates and the slowing economy are still weighing on small businesses, with the Russell 2000’s aggregate profit dropping 10% year-over-year in the second quarter, and many companies within the index issuing disappointing earnings guidance.

BofA analysts therefore expressed a preference for mid-cap stocks in the near term, noting their stronger earnings potential and reduced sensitivity to interest rate changes. They argue that mid-caps tend to outperform small caps during times of uncertainty, offering more stability for investors concerned about an economic downturn or fewer-than-expected rate cuts.

Within the small-cap sector, the analysts favor value stocks over growth stocks, noting that larger small-cap companies tend to outperform the smallest ones during periods of Federal Reserve rate cuts.