Russell 2000 looks set for a catch-up with large-cap indices
One of the primary drivers behind the Russell 2000's underperformance is the Federal Reserve's prolonged interest rate pause. Small-cap stocks are generally more sensitive to interest rate fluctuations as these companies typically carry more debt relative to their earnings than large-caps. This higher leverage means that changes in interest rates have a greater impact on their financial health, as high rates elevate the cost of servicing debt. In addition, small caps generally have weaker balance sheets and less access to capital markets, making it harder for them to absorb higher borrowing costs or secure favourable refinancing terms.
The Fed has kept interest rates steady between 4.25 per cent and 4.5 per cent since December 2024, and while markets expect two rate cuts later this year, in September and December, this cautious approach has put pressure on the Russell 2000.
Another key factor behind the Russell 2000's underperformance is the uncertain economic backdrop created by President Donald Trump's reciprocal tariff policies on the US' trading partners.
Small-cap companies are generally more domestically focused and have less pricing power, making them more vulnerable to disruptions in supply chains and increased input costs caused by tariffs. The uncertainty around trade policy has led to cautious consumer and business spending, dampening growth prospects and reducing investor risk appetite for small-caps.
However, from a technical standpoint, the Russell 2000 could be poised for a catch-up with the large-cap indices. The index is holding above the 12-day Simple Moving Average (SMA) following a bullish crossover with the 26-day SMA, a popular technical analysis strategy signalling bullish short-term momentum. The index also broke out above the neckline resistance of an inverse head and shoulders formation at 2,110 points on Jun 6, alongside a breakout of a downtrend resistance line. These are positive signals supporting a bullish recovery. Additionally, the Moving Average Convergence Divergence technical indicator made a fresh bullish crossover recently and is holding above the zero line, showing signs of renewed accelerating bullish momentum, which increases the likelihood of further gains.
In conclusion, the Russell 2000's lacklustre performance this year is the result of a confluence of factors, including a prolonged interest rate pause by the Fed and economic uncertainty from trade tensions. However, bullish technical signals for the index currently could see it play catch-up with the large-cap indices and rally towards the 2,320 points level.
The writer is research analyst at Phillip Securities Research
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