A trader works on the floor of the New York Stock Exchange (NYSE) at the opening bell in New York City, on April 3, 2025.
Charly Triballeau | Afp | Getty Images
Small-cap stocks, which were once thought to be primary beneficiaries of President Donald Trump’s policies, entered bear market territory on Thursday after a massive stock market rout that followed the administration’s sweeping and aggressive tariff rollout.
The Russell 2000 Index was down more than 5% on Thursday, bringing its losses from its November 25 record close to about 21%. On Wall Street, a 10% pullback is considered a correction, but a 20% decline is a bear market. The S&P 500 and Nasdaq Composite are both in correction territory, while the Dow Jones Industrial Average is just below that mark.
“They’re getting hit because the economy is softening. That’s going to hurt profits,” Keith Lerner, co-chief investment officer at Truist, told CNBC. “On the other side, they’re still paying high levels of interest payments on debt because they have more of this floating-rate debt.”
“They’re getting squeezed on both sides,” he said.
This is a sharp reversal from the gains seen in the trading days following November’s election, with small caps viewed as beneficiaries from deregulation, lower tax rates and even tariffs since the group has fewer multinationals than large cap stocks.
The Russell 2000 closed out that election week with an 8.6% advance, almost four percentage points higher than the 4.7% weekly gain of the S&P 500. Along with that, it became one of the hottest Trump trades. In fact, Tom Lee – managing partner and head of research at Fundstrat – said at that time that small caps could outperform by more than 100% over the next couple of years.
Russell 2000 since November 25 record
But the Russell 2000 was dragged lower Thursday in names like Victoria’s Secret and Urban Outfitters, which source a lot of products from other countries and could see significantly higher costs and lower margins from the tariffs.
And the group is particularly sensitive to economic shifts given their small size, and therefore less financial flexibility as large-cap stocks. JPMorgan predicted that if Trump’s sweeping new reciprocal tariffs remain, the U.S. economy will likely fall into a recession.
The Russell 2000 previously neared bear market territory in March amid a monthlong market sell-off spurred by uncertainty surrounding Trump’s tariffs plans and growing concern on the Street of a slowing economy.
“Small caps, in the first half of an economic recession, are usually down 13%, so it’s already worse than where we were for the average recession,” said Steven DeSanctis, an equity strategist covering small- and mid-cap companies at Jefferies, in an interview with CNBC. “For the average bear market, small caps are down 26%, so we’re nearing that number.”
Where’s the bottom?
While small caps are in turmoil right now, DeSanctis believes the group could eventually find a bottom, especially if the Federal Reserve starts lowering interest rates again.
Traders are currently pricing in a 58.5% chance of four quarter-percentage-point cuts by year-end 2025, with more than 90% odds of the next cut being at the central bank’s June meeting, per the CME FedWatch Tool.
“If the economy gets weak enough, do we get support from the Fed? We say yes. That’s usually good for small caps,” the equity strategist said.
DeSanctis added that the path from here might look like a “tough” first two quarters, though no recession, before the Fed possibly comes to the rescue in the summer. From there, he anticipates that some of the concerns surrounding tariffs – which could raise input costs for businesses – may be resolved, prompting the market to focus on deregulation once again.
Lerner, who is underweight small caps, is similarly constructive. He noted that in addition to deregulation, a greater focus on tax cut extensions and a return of animal spirits leading to a pickup in mergers and acquisitions should provide an opportunity for small caps to do well later in the year, or whenever investors feel that the worst of the economic outlook is behind them.
What’s more, because things “don’t move in a straight line,” it “wouldn’t be surprising” for small caps as well as large caps to soon see an “oversold bounce,” Lerner said.
Lerner doesn’t believe large caps will face a similar fate of entering bear market territory as small caps. The S&P 500 is still a considerable distance away from a bear market, being more than 11% off its Feb. 19 high in correction territory.
“With small caps being down 20%, it tells you they’ve already been down – the bear market didn’t start here. It’s been going on for several months,” the co-CIO said. “Correspondingly, large caps are also down, but they are down about half relative to small caps. Our base case for large caps is you may see further downside, but we’re not calling for a bear market.”
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