Key trends in small caps: Recession and tariff fears, reallocation to bigger stocks

Last week, investors rotated capital into large caps and stocks of companies with higher debt levels. In a continuation of the year-to-date trend, the Russell 2000 underperformed the S&P 500, which signals growing market concerns about a potential recession.  

On Friday, March 28, the Russell 2000 dropped alongside the broader market, posting the worst one-day performance of the month. The small-cap index fell over 2%, ending at 2,023.27 points. Last week, it lost just over 1.6%, which brought its year-to-date decline to about 10%.  

Meanwhile, the S&P 500 slid 1.53% last week and is now down just over 5% since the beginning of the year.  

“If you want one clear signal that the market is worried about recession more than anything else, then look at the Russell,” David Kelly, JPMorgan Asset Management’s chief market strategist, told the New York Times in mid-March. Smaller companies are more sensitive to economic shifts — they operate with thinner margins, which can dwindle in a downturn, and they have less flexibility than larger firms.  

Freedom Broker noted in a report published on Friday that investors have been rotating out of small caps and into large-cap stocks. This trend is evident when comparing the performance of the Russell 2000 to the S&P 500 and within the Russell 2000 itself. Last week, the largest 25% of companies in the Russell 2000 gained an average of 0.35%, while the smallest companies lost 2.09%. Over the last three months, the divergence is even more striking: the former are down 3.19%, while the latter have plunged 19.08%.  

In addition, last week investors shifted into companies with higher debt levels (as measured by debt/EV), a trend particularly visible in micro caps, Freedom Broker noted. The market expects two Fed rate cuts this year, which would likely reduce borrowing costs for businesses.  

Freedom Broker anticipates the Russell 2000 will trade within a range of 2,025-2,110 points this week.  

The market will be focused on President Trump’s so-called “liberation day” on April 2, when his administration is set to impose retaliatory tariffs on all countries. Analysts surveyed by Portfolio Adviser have warned that the widening tariffs risk a new bout of inflation in the U.S., which would complicate a potential bounceback for small-cap stocks.  

Also on the calendar this week: The U.S. will release official unemployment data for March, and ISM and S&P will publish new business activity reports.