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Small-cap stocks are finally playing catch-up, leaving a market — which has been burned before — wondering if this time is for real.
Fed Chair Jerome Powell reenergized the stock market on Friday as investors took his Jackson Hole remarks as a wink and a nod that a cut will be coming in September. Not surprisingly, interest rate-sensitive areas surged ahead, putting the small-cap Russell 2000 index up around 4% over the past month.
The boost is a long time coming. While the S&P 500 (^GSPC), Nasdaq (^IXIC), and even the Dow (^DJI) have enjoyed plenty of record highs recently, the euphoria has not trickled down. The Russell 2000 (^RUT) hasn’t seen a record close since 2021, despite nearly making it back to the top last fall before crashing once again as the trade war took off.
Even as megacap tickers maintain staggering highs, some analysts see this small-cap run as the beginning of a rotation, signaling an end to the longstanding dominance of the tech giants.
A broadening of the market rally would coincide with the next phase in the economic cycle. And it would allow sky-high valuations to take into account the skepticism of the AI trade, which resurfaced last week amid chatter of corporate restructuring, a lack of return on AI investments, and fear of an AI bubble.
Small cap has plenty going for it besides rate cuts and AI angst. In a note to clients Monday, Mark Hackett, chief market strategist at Nationwide, pointed to fiscal stimulus, trade deals, and dollar weakness, which would favor cyclicals, small caps, and international equities. He also considered the downstream benefits of AI investments, which the broader market is only beginning to capture, “setting the stage for more balanced leadership,” as he wrote in an email Monday.
But Monday’s market action provided the first hint that all that might still not be enough for small caps, as the Russell went back to its lagging ways. While one session alone is hardly proof that the rotation idea is off base, there’s a sense that investors betting against Big Tech do so at their peril, especially as Nvidia (NVDA), the most valuable company on Wall Street and the flag bearer of the AI trade, reports on Wednesday.
Then there’s the “be careful what you wish for” of it all, which Lori Calvasina, head of US equity strategy at RBC Capital Markets, pointed out in a note Sunday. Though the small-cap world has yearned for cuts for years, they are definitionally a mixed blessing, as the very thing that prompts them is a flagging economy, under which small-cap stocks historically underperform.
“We still don’t think cuts alone can bring about a period of sustainable Small Cap outperformance without a stronger economic backdrop than the one currently in place or being forecast by the economic community at large,” Calvasina wrote.
Whether a rotation from big to small happens remains to be seen. But one thing we have seen: Big Tech’s knack for making money in any environment, whatever the interest rate.
Hamza Shaban is a reporter for Yahoo Finance covering markets and the economy. Follow Hamza on X @hshaban.
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