Why small-cap investors should be wary of 'manic' sentiment in markets

A gauge of investor sentiment from Bloomberg Intelligence “approached manic” in June. This could portend a relative downturn in the small-cap space, however.

U.S. equities is showing signs of overheating, foreshadowing trouble for the nascent recovery in small caps, writes Bloomberg. 

A Bloomberg Intelligence investor sentiment gauge swung from panic mode in April to what is described as “approaching manic” in June. Bloomberg Intelligence strategists led by Gina Martin Adams found that once the gauge hits manic, markets tend to cool off and smaller stocks start to lag their larger peers.

A second sign of stock market euphoria is investors' piling into speculative and volatile edges of the market despite lingering uncertainty around the economy and geopolitics, as Bloomberg reported in a previous article.

Meanwhile, the so-called Buffett indicator is flashing red. It compares the total market capitalization of a country’s stock market to its GDP. Any number above 110% means stocks are overvalued, explains MarketBeat. If that percentage goes over 140%, the market is deemed strongly overvalued. As of today, July 8, it is 207.8%.

Small-cap shares have traditionally been considered a leading indicator, Bloomberg notes. They "work in the early stages of a rally and outperform in good periods," explains Mark Hackett, chief market strategist at Nationwide. "And when the market drops, investors instinctively sell small caps," he adds. 

The most recent and striking example of this behavior came after Trump's victory in November, when the market rallied sharply. By the end of January, the Bloomberg Intelligence investor sentiment gauge soared to manic levels. Over the next three months, the S&P 500 index fell 7.8%, while the Russell 2000 sank 14.0%, battered by Trump's tariff announcements and fears on the future of the AI boom, Bloomberg notes. 

Dennis DeBusschere of 22V Research recommends staying long small caps. In his view, the combination of slowing but stable economic growth and the tax and spending deal points to a growing economy in the first half of 2026, which is "positive for the riskiest or most economically sensitive stocks." 

Nevertheless, as tariff negotiations between the U.S. and other countries continue and the state of the economy is still in doubt, some strategists advise sticking to large companies with strong balance sheets and higher earnings. One such voice is Barclays strategist Venu Krishna, who prefers large-cap stocks for their improving earnings revisions, better margins, robust balance sheets, and greater leverage to macro growth drivers, such as AI.

The AI translation of this story was reviewed by a human editor.