Why Lower Rates Will Be Worth the Wait

By Lucas Downey, Editor, TradeSmith Alpha Signals

Is that… Paul Revere?

”Rate cuts are coming! Rate cuts are coming!”

Nope, that’s just me!

One month ago, I prepared you with a playbook for when the Fed cuts rates. Stocks tend to do well when rates drop and the economy remains resilient.

The news out of Jackson Hole Friday has only furthered my conviction that this is exactly what we’ll get. Fed Chair Jerome Powell uttered powerful words, suggesting “theshifting balance of risks may warrant adjusting policy.”

If you ask me, that points to a high likelihood of a September cut.

More important, stocks staged a wicked rally after these words… with all areas of the market participating.

Impressively, small caps – as measured by the S&P Small Cap 600 – are up nearly 4% as I write.

Folks, I have gone on record discussing my preference for smaller groups as we head into a new rate-cutting cycle.

Today we’ll offer up new evidence that points to big upside for the long-term lagging group.

When the Fed continues a cutting cycle… especially in an environment like this… stocks boom.

History holds the evidence, and we’ll look it over today.

Then I’ll show you an under-the-radar AI play ready to take off!

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Stocks Surge When the Fed Restarts Rate Cuts

Not all rate cuts are created equal.

A month ago, we learned that equities surge when the Fed cuts rates, and the economy isn’t in recession and doesn’t fall into one 12 months later.

In that scenario since 1990:

Three months later, the S&P 500 (SPX) jumps 5.7%, while the Nasdaq 100 (NDX) climbs 14.2%.
Six months later, the SPX ramps 9.1%, and NDX rips 18.8%.
12 months later, SPX and NDX soar 14.2% and 33.5%, respectively.

That’s about as bullish of a signal as you’ll find:

And it makes sense that lower rates would spell good fortune…

Balance sheets get healthier. Debt servicing gets less costly. That frees up companies to invest in growth.

But let’s take rate cuts a step further with today’s signal study.

We’re in a unique situation. The Fed is resuming rate cuts after 9+ months of no moves.

That’s a rare signal that we haven’t seen in a long time. A resumption of rate cuts after a pause of at least five months has occurred just four times.

Below I’ve included each period, and for starters, will view the forward S&P 500 performance:

First was 1995, right before tech stocks started seriously taking off. This is the period that lines up most closely with today.
That’s because the other signals were November 2002 and June 2003, the years after the dot-com bust…
And October 2008 – just a few months before the market bottomed from the Great Financial Crisis.

Note how stocks sputtered initially in the dot-com bust but found their footing six months later.

Notably, in all instances large caps were never lower after 12 months:

Even in this rare rate scenario when the U.S. economy was coming out of recession and a stock market crash, the market was higher just 12 months later.

And that’s nothing like where we’re at today.

But let’s turn it up a notch…

It turns out that smaller companies perform markedly better in this same scenario.

After all, smaller firms are undercapitalized compared to larger companies and they tend to carry higher debts. As interest rates fall, smaller companies tend to tap the banks for loans – which fall under the purview of the Federal Reserve’s key rate.

So let’s use the above framework to examine how both small and mid-caps perform in this same scenario…

I’ve included the S&P 500, S&P MidCap 400, and S&P SmallCap 600 for comparison.

Similar to large caps, the bigger gains show up six months and later with:

Six-month average returns for small caps at 4.6%, and mid-caps rally 4.9%
12-month gains for small caps of 23.7% and 22.7% for mid-caps
Zoom out 24 months, and small caps rip 43.9% while mid-caps fly 42.7%.

Also note that 12 months out and later, none of these benchmarks were ever lower:

If “rate cuts are coming,” and Friday’s Jackson Hole speech seemed to convince the market that they are…

That means buy small caps!

And I believe this is why we are seeing such a big outperformance on Friday, with the S&P SmallCap 600 up nearly 4%, while the S&P 500 is up 1.6%.

Smart investors know there’s more upside in smaller, more rate-sensitive companies.

With this in mind, let’s focus on one small cap that can really perform under this backdrop… one that’s in the hot AI space.

Talen Energy (TLN) Has Superstar Potential

Two months ago, I drew your attention to one of my favorite nuclear power plays, Talen Energy (TLN).

Nuclear is incredibly important for hyperscalers needing energy to fuel their AI buildouts.

Talen, which has been around since 2014, is a major beneficiary of this trend.

Don’t let its small $16.3 billion market cap fool you!

In 2024, revenues clocked in at $1.8 billion. This year in 2025, estimates peg sales to reach $2.3 billion.

Look out to 2026, and revenues are expected to accelerate to $3.7 billion.

This good fortune is due to the company’s ability to ink partnerships with hyperscalers.

They’ve recently announced a deal with Amazon. From a Talen Energy press release:

“Talen enters power purchase agreement for 1,920 megawatts of carbon-free electricity at full quantity to support Amazon operations, and explore SMR [small modular reactor] technology.”

Deals like this have caused the shares to outperform in 2025, up +64% at writing.

And what makes this name interesting today is the fact that the stock has fallen 5.9% over the past five days:

A fall of 5.9% or greater over five days has only occurred 42 times in TLN’s 11-year history.

And here’s what’s happened next:

Two weeks later, shares jump 7.6%.
One month later, the stock climbs 12.9%.
Two months later, the stock averages a 24.6% gain.

This is the type of setup you should consider with small caps in favor over the next year. And with this signal study, the gains should start soon.

Let’s seal the deal with the outstanding rating that the Quantum Edge System hands TLN.

With a score of 96.4, Talen is firing on both fundamental and technical cylinders. Few companies can boast such a powerful rating:

There you have it.

The Fed is set to cut interest rates next month…

And you should make the most of it by owning high-quality small caps in leadership position.

Don’t waste this opportunity by buying low-rated stocks that lack a green Quantum Score.

TradeSmith software finds and delivers the top names racing higher day after day.

Why Lower Rates Will Be Worth the Wait