--- title: "Small caps are still riding high despite latest setback. But more trouble could lie ahead." type: "News" locale: "en" url: "https://longbridge.com/en/news/286645415.md" description: "The small-cap Russell 2000 index fell 2.4% on Friday, marking its worst decline since November, despite a year-to-date gain of 12.6%. Rising long-term Treasury yields are testing the sustainability of small caps' recent outperformance, as higher rates can negatively impact smaller companies with more floating-rate debt. Analysts suggest that for small caps to continue rising, a more stable macroeconomic environment is needed, including lower interest rates and easing inflation expectations. Improved earnings growth has supported small caps, but many companies remain unprofitable." datetime: "2026-05-16T12:30:08.000Z" locales: - [zh-CN](https://longbridge.com/zh-CN/news/286645415.md) - [en](https://longbridge.com/en/news/286645415.md) - [zh-HK](https://longbridge.com/zh-HK/news/286645415.md) --- # Small caps are still riding high despite latest setback. But more trouble could lie ahead. By Frances Yue The small-cap Russell 2000 led U.S. stocks lower on Friday - yet it has outperformed all major indexes except the Nasdaq in 2026 The Russell 2000 on Friday posted its worst one-day decline since November. Small caps have finally started to break out, after years of lagging behind megacap stocks. But the latest surge in long-term Treasury yields is testing how durable that breakout might be. The Russell 2000 index RUT fell 2.4% on Friday to end at 2,793.30, its worst one-day decline since Nov. 13, according to Dow Jones Market Data. The small-cap gauge was mostly weighed down by rising Treasury yields, as the 30-year Treasury rate BX:TMUBMUSD30Y hit its highest level since July 17, 2007. Higher yields can be especially painful for smaller companies, which tend to carry a larger share of floating-rate debt. Their access to cheaper financing is often more limited than larger firms. The selloff matters because it puts one of this year's most important market rotations to the test. Investors have been betting that small caps can finally catch up after years of lagging behind megacap technology stocks, helped by improving earnings, cheaper valuations and broader interest in artificial-intelligence-related infrastructure. Even after Friday's decline, the Russell 2000 was still up 12.6% year to date, compared with a 8.2% gain for the S&P 500 SPX. But the surge in long-term yields is a reminder that a more hostile macro backdrop could create problems for small caps, which have only just gotten their mojo back after years of trailing their larger peers. Rising rates could send investors running back to the safety of Big Tech. Indeed, semiconductor stocks and other companies have largely led the market's latest leg higher, although small-cap tech stocks have performed well. See: These smaller tech stocks are punching well above their weight "We're very fickle with the small-cap trade, unfortunately," said Mark Hackett, chief market strategist at Nationwide's Investment Management Group. Part of the problem is that the broader market rally is still being led by the easiest and most liquid ways to gain exposure in a momentum- and technically driven market, Hackett noted. "The rally is very much driven by investors trying to get exposure, and institutionally that's being done through things like S&P index futures. On the retail side, it's much more in the high-beta technology space," Hackett said in a phone interview. "When you have technically driven market rallies like we've seen, investors are just going for the fastest, quickest, most convenient way to get exposure, and that's generally going to be large-cap tech." For small caps to keep rising, the macro backdrop likely needs to become more stable, Hackett said. That would mean some moderation in energy markets, easing inflation expectations and, ideally, lower interest rates, he said. "We have to get back to a more 'normal' environment for the small caps to work," Hackett added. If that happens, investors may be able to focus more on the improving fundamentals underneath the small-cap universe. "Then you start looking at the fundamentals underneath the small-cap space, and it starts to get pretty exciting." Earnings-backed gains Small caps' outperformance so far this year has been supported primarily by improving earnings, said Oren Shiran, portfolio manager at Lazard. In particular, small-cap earnings growth appears to have reached an inflection point in August 2025, according to Shiran. Looking at trailing 12-month earnings per share for profitable small-cap companies, EPS growth was mostly negative through 2023 and 2024; improved to roughly break-even in early 2025; and then began to move meaningfully higher in August 2025, Shiran said in a call. Since then, earnings growth has continued to improve. To be sure, the measure does not capture the entire small-cap universe, because about 40% of small-cap companies are not profitable, Shiran noted. At the same time, investors have also become more willing to pay up for small-cap earnings. The Russell 2000's forward price-to-earnings multiple - which measures how much investors are paying for expected earnings over the next 12 months - rose to 16.9 on Thursday, from 15.1 last month. That put it 11% above its long-term average and at its highest level since November, according to a note by Jill Carey Hall and Trey Brown, strategists at BofA Global Research. What's more, small-cap stocks may also be an underappreciated AI play, Shiran added. While Nvidia (NVDA), Microsoft (MSFT), Alphabet (GOOGL) (GOOG) and other hyperscalers - companies operating massive cloud-computing platforms and data centers - have dominated the headlines, many companies tied to AI infrastructure sit further down the market-cap spectrum and may benefit from the enormous spending on AI, he said. "When you look at Nvidia, Google, Microsoft and the hyperscalers, they're really taking a lot of the headline news," Shiran said. "But all of the picks and shovels, all of AI infrastructure - the big majority of it sits in small caps." \-Frances Yue This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal. 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