As consumers and investors anxiously search for telltale signs of where the economy is going, amid wild swings in the stock market and plunging consumer sentiment caused by President Trump’s foreign trade policy, a less-closely watched index is showing signs of trouble up ahead.
The Russell 2000, a stock index made up of small-company stocks, is down more than 18% since its peak in November when Mr. Trump was elected. While the index initially rose on optimism that the new administration would create a more business-friendly environment, those hopes have been quickly dashed by an escalating trade war, initiated by tariffs imposed by Mr. Trump against some of our closest trading allies.
As a result, the small-cap index is now headed toward a bear market, defined by a decline of 20% or more from its most recent high.
“Some small caps like the Russell 2000 were outperforming the S&P 500 after the election, presumably on the theory that there was going to be substantial deal activity, because these companies are more likely to be acquired and merge than the largest of the large-caps,” Daniel Hornung, former deputy director of the National Economic Council, told CBS MoneyWatch.
“There was a sense that there was going to be deregulation and easier environment for transactions to occur, but there’s a huge amount of uncertainty hanging over the economy and markets right now that makes it really difficult for transactions to happen,” Hornung explained.
With tariffs such as a 25% tax on steel and aluminum imports threatening price hikes across a broad spectrum of industries, the attention of small- and mid-size businesses is no longer on growth but survival.
Canary in the coal mine
The Russell 2000 comprises smaller companies across a variety sectors, and is widely considered to be a benchmark for small U.S. stocks. Unlike the tech-heavy S&P 500, it is not weighted toward a particular industry.
For that reason, the index is more sensitive to changes in the economy, particularly downturns, because its companies are smaller and more exposed to market shocks than larger ones, given that they operate on thinner margins and typically have higher borrowing costs.
“It’s more diversified at the sectoral level, so it is more representative of U.S. growth dynamics,” Skanda Amarnath, a macroeconomist and executive director of Employ America, told CBS MoneyWatch.
Some of the Russell 2000 companies include commercial jet engine company FTAI Aviation, grocery chain Sprouts Farmers Market, plant-based food company Beyond Meat, and language learning tool Duolingo.
Not pointing to a recession
While the Russell 2000 is only two percentage points away from entering bear market territory, Bank of America Research economists say it’s not pricing in a recession, and they still expect the economy to grow this year.
“Historically in recessions the Russell 2000 has sold off close to 40% on average,” said Jill Carey Hall, head of U.S. small- and mid-cap strategy at Bank of America Research. “So it’s not pricing in greater than a 50% probability of a recession at this point.”
Still, small businesses could be in store for heavy profit losses.
Based on the levies currently in place on Canada, Mexico and China, and assuming retaliatory tariffs, Bank of America estimates that the earnings hit could be three times larger for small caps than for large caps.
“These companies have much thinner margins, so a rise in input costs hurts them more,” Carey Hall said.
