Sometimes in life it’s the smallest things that speak the loudest.
Take the Russell 2000 (^RUT), the one-time darling among investors following the election of President Donald Trump. The small-cap index has severely underperformed the Dow Jones Industrial Average, S&P 500 and Nasdaq Composite these past three months by tanking a worrisome 8%. That dismal showing is despite another solid earnings season that saw double-digit profit growth for many companies.
Seeing as the Russell 2000 measures the performance of mostly small U.S. centric companies, it’s ongoing weakness suggests a sharp slowdown in domestic economic growth in early 2019. It could also be hinting at a mild recession in the U.S. spurred by a recipe of rising interest rates and waning effects of the Trump tax cut stimulus.
Why it should matter to you: The Russell 2000’s less than inspiring performance could be boiled down to several factors, said SunTrust Chief Markets Strategist Keith Lerner. As the Federal Reserve charts a path to at least four interest rate hikes in 2019, it will become more challenging for weaker companies — like many in the Russell 2000 with small operations — to access capital. Lerner notes that about one-third of Russell 2000 companies have not produced earnings over the past twelve months.
Further, the cost of debt for those companies that do manage to raise funds is on an uptrend. In turn, that has an outsized impact on the bottom line of smaller companies.
“There are concerns that U.S. economic growth will slow next year from this year, hurting small caps,” Lerner adds. Investors are pricing in that strong probability today by way of the Russell 2000.