A recent resurgence of "higher-for-longer" interest rate expectations has resulted in a continued bout of underperformance for small-cap stocks. As a result, the benchmark Russell 2000 stock-market index is now at risk of breaching an important support level.
The Russell 2000 (RUT), which comprises the 2,000 smallest companies within the Russell 3000 (RUA) based on market capitalization, saw a decline of 0.4% to near 1,848 during afternoon trade. If the index finishes below 1,845.76, it would signify the first close below the technically significant 200-day moving average since June 5, as reported by Dow Jones Market Data.
Earlier on Wednesday, the index reached a session low of 1,842.99 (refer to the chart below). This potential downward movement would also break a streak of 68 consecutive trading days above the 200-day moving average, which had been the longest since a span of 226 trading days between September 25, 2020, and August 18, 2021.
Traders and technical analysts often consider the 200-day average as an important indicator for a market's long-term trend.
So far, the Russell 2000 has significantly trailed behind the large-cap S&P 500 (SPX) throughout September and year to date. While the small-cap index has experienced a 2.7% decline this month, it has only managed to gain 5% year to date. However, there is still a positive growth of 0.9% when compared to the previous year. On the other hand, the S&P 500 has encountered a 0.7% decline in September but has demonstrated an overall rally of 16.6% for this year and a remarkable increase of 13.8% from its level a year ago.
Gains in Large-Cap Indexes Driven by AI-Powered Megacap Tech Stocks
The large-cap indexes have experienced significant gains, largely attributed to the rally in megacap tech stocks propelled by artificial intelligence. However, investors looking for a broader market rally have remained optimistic about the potential benefits for small-cap stocks. These smaller companies, which are more closely tied to the economic cycle, could thrive as concerns over a recession or a so-called hard landing due to the Federal Reserve's aggressive monetary tightening campaign give way to resilient economic data.
Unfortunately, despite expectations of better-than-expected economic data and the possibility of a soft landing, small-cap stocks have struggled. Sameer Samana, a senior global market strategist at Wells Fargo Investment Institute, expressed surprise over this weakness in a recent note.
One factor contributing to this underperformance could be the regional banking issues experienced in the spring. These problems have further limited credit and financial opportunities for small businesses and are likely to result in new regulations for small and midsized banks. Samana believes that while small-cap stocks may eventually have their moment to shine, it is premature to increase exposure to these companies at this time.
Furthermore, the approaching fall season historically tends to be a weaker period for equities. Moreover, the looming threat of inflation may force the Federal Reserve to raise interest rates to higher levels and for a longer period of time. Such a move increases the risk of a policy mistake and adds more uncertainty for the markets.
In summary, while large-cap indexes continue to benefit from the rally in megacap tech stocks driven by artificial intelligence, small-cap stocks have struggled to keep up. Economic concerns and potential policy mistakes contribute to the uncertain outlook for small-caps in the near term.