Riskier stocks now in correction territory with Russell 2000 off 11% from peak

The Russell 2000 index, which tracks U.S. smid-cap stocks, entered a technical correction for the first time since March after falling 2.2% on Wednesday. A correction is generally defined as a decline of more than 10% from the most recent peak. A drop of more than 20% marks the start of a bear market.

The Russell 2000 has slid 11.3% from its August high. Wednesday’s selloff was broad, with roughly five stocks in the index declining for every one that rose, Bloomberg reports.

Investors sold risky assets on Wednesday after U.S. inflation data showed that consumer prices rose in September at their fastest annual pace since April, while core inflation came in above expectations. Traders consequently revised their expectations for Fed rate increases through year end: markets are now pricing in two more hikes in the coming months.

“Small caps are highly sensitive to rates, and to the extent that today’s print adds risk of higher policy rates, then that’s a bad sign for small caps,” Stefano Pascale, head of U.S. equity derivatives research at Barclays, told Bloomberg.

The Russell 2000 outperformed the broad-market S&P 500 for much of the year, as the performance of small-cap stocks is closely correlated to economic growth. Strong consumer spending and massive business investment in AI infrastructure supported the economy, Bloomberg writes. However, the Russell 2000 lost its lead last month after the Fed raised interest rates and bond yields, including U.S. Treasury yields, surged. Smaller companies tend to be more sensitive to interest-rate changes than large caps, Bloomberg notes.

September’s acceleration in inflation raises the risk of further tightening in financial conditions, which would be “a continued longer-term headwind for small caps,” as well as consumer and transport stocks, Dennis DeBusschere, president and chief market strategist at 22V Research, told Bloomberg.

The Russell 2000 posted its strongest first-half performance in 35 years, followed by a major rebalancing that removed several of its highest-quality, fastest-growing companies. Bloom Energy, Credo Technology Group Holding, Sterling Infrastructure, and TTM Technologies collectively accounted for around two thirds of the Russell 2000’s gains through June 29, after which all four companies moved to the Russell 1000.