Small-Cap Stocks Just Did Something They Haven't Done Since 2018. Is It Finally Time to Buy?
The rate-driven sell-off in the Russell 2000 creates a potential buying opportunity.
The Russell 2000, a small-cap index, has gained 2% over the past week, marking its longest streak of consecutive weekly gains since 2018. This rise occurred during a week where both the S&P 500 and the Nasdaq 100 saw declines. Experts suggest that this divergence could be due to two factors: small-cap stocks tend to be more debt-heavy and may benefit from falling interest rates, and growing concerns about artificial intelligence financing, negative cash flows, and rising credit risks.
The 10-year Treasury yield has recently dipped below 5%, indicating a potential "flight to safety" that favors small-caps due to their higher exposure to rate changes. Small-cap earnings are expected to grow more than 20% year-over-year, improving their valuation from a previously low 18 times earnings. However, the Fed may raise rates again by mid-2027, which could reverse small-cap gains if yields climb.
The iShares Russell 2000 ETF is currently about 9% below its August high, making it a potential buy-the-dip candidate. Long-term investors may consider diversifying into small-caps, given their improved earnings outlook and better relative value, particularly if the current flight to safety trend continues.
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