Watch This Surge in Small-Cap Speculative Action for Signs of Sustained Momentum
The track record for small stocks is very poor, but is it different this time?
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The Russell 2000 Small Cap Index IWM has been lagging the senior indexes for five years. There have been some brief periods of outperformance as rotational action picks up, but it has fizzled out quickly and never gained substantial momentum.
Small caps are lagging again in 2025, but there has been some recent outperformance. On Tuesday and Wednesday, the Russell 2000 advanced nearly 5% while the S&P 500 was up 1.4% and the Magnificent Seven gained just 0.78%.
These periods of outperformance are rare, but we've seen a recent surge in speculative action in smaller stocks and cryptocurrency-related names. Bitcoin IBIT hit a new all-time high on Wednesday, and the Bullish (BLSH) crypto-related IPO had a hot open.
Most notably, there has been a surge in smaller stocks moving up more than 10% in a single day. Even when the overall breadth was poor, there has been a large supply of these big moves in secondary stocks.
Part of the reason for the recent action is the small-cap earnings season, which triggered some news flow, and another reason is that there are increased odds of Fed rate cuts. Smaller stocks tend to use more debt and are highly leveraged, so they are more sensitive to interest rates than mega-cap names that don’t have significant debt.
The big question at this point is whether this rotational action into small caps can continue. Based on the track record in recent years, it appears unlikely, but there are a few things that favor more small-cap relative strength. The first is valuation versus big-cap technology. There is some extremely aggressive valuation, as there are some building signs of some slowing in the economy. Many small caps are not profitable, but there are some attractive valuations in little-known names.
Technical conditions are also better for many stocks. On Wednesday, there was a surge in new 12-month highs to nearly 1,700 names. These are mostly stocks that are just breaking out at this point and are still not as extended as many big caps.
The biggest obstacle to sustained outperformance by small caps is overall market conditions. When big caps start to struggle, it impacts overall market confidence, and there is hesitation to put more money into more volatile smaller stocks, even if they have attractive qualities.
Most of the recent rotation into small caps has fizzled out when dip-buyers shift back to big caps after relatively minor pullbacks.
We have the producer price index and retail sales news coming on Thursday, and that could have some impact on the building optimism about a Fed rate cut at the next meeting in September. Fed Fund futures indicate that a cut is a near certainty at this point, but that can change quickly if the wrong data hits.
We have a quiet open on the way.
At the time of publication, DePorre had no position in any security mentioned.
