Small Caps Showing Strength Amid S&P 500 Highs
The S&P 500 might be nearing new record highs, but it seems the small-cap stocks are taking center stage this week. The Russell 2000 index has risen 0.8%, outperforming the S&P 500, Nasdaq, and Dow. This positive trend has positioned the Small Cap Index for its ninth weekly victory, with its 2025 losses now reduced to below 4%. Despite the uplift, small-cap stocks are still behind year-to-date.
Jonathan Klinski, BTIG’s chief market technician, suggested a “small cap summer” in a memo last weekend, reflecting this trend. Still, the primary reasons behind this rally are somewhat unclear, as the overall economic landscape hasn’t changed much in the last month. One aspect might be related to market positioning; small caps have significant room to catch up to their larger counterparts.
A report from Bank of America noted that short interest in small-cap stocks is even more pronounced compared to larger ones. Furthermore, the latest economic indicators are trending positively, albeit modestly. For instance, inflation metrics haven’t significantly impacted tariffs, which is beneficial for small enterprises. If this trend allows the Federal Reserve to lower interest rates, it could have a positive macroeconomic impact, according to Angelo Kourkafas, a senior investment strategist at Edward Jones. He explained that small caps are particularly sensitive to high-interest conditions, which has posed challenges for the Russell 2000.
Lowering rates could also help maintain the labor market, avoiding significant job losses. If the worries about a recession in 2025 diminish, investors might become more optimistic about the outlook for 2026, especially if trading conditions stabilize and new tax cuts come into play. “This year, earnings estimates have been adjusted for both small and large caps, but the 2026 estimates have remained stable,” Kourkafas noted. He expressed a positive outlook over the next 12 months, suggesting that small-cap revenues could outperform large-cap revenues if the macroeconomic environment stays steady.
However, Kourkafas hinted at a cyclical re-acceleration sometime ahead. Given the recent years of earnings struggles for small caps, he speculated that this shift could come around 2026.
