The highly anticipated Wall Street shift towards smaller firms that was gaining traction has suddenly stalled.
Stocks that were previously attracting significant investor attention are now experiencing a sudden exodus as investors reevaluate their expectations for US economic growth. Amid a turbulent week for equities, traders withdrew $2.6 billion from the iShares Russell 2000 ETF (ticker IWM) in a span of five days, the largest outflow in nearly three years, according to data from Bloomberg. Many are speculating that the worst of the sell-off is yet to come, as short interest as a percentage of shares outstanding on the fund has surged to its highest level since December, based on data from IHS Markit Ltd.
This pullback comes after a period where traders were pouring money into previously overlooked strategies that propelled the Russell 2000 – the underlying index for IWM – to a 10% gain in July, its largest monthly increase since the end of last year. However, the index is currently down by approximately 8% for August, with concerns rising surrounding the US economy’s health and the Federal Reserve’s ability to prevent a recession.
According to Eric Balchunas at Bloomberg Intelligence, “The trading crowd is abandoning small caps quickly. It was enjoyable while it lasted (for about two weeks).”
Investors briefly showed enthusiasm for small-cap firms in July, speculating that factors like lower interest rates would be advantageous. These firms had been overshadowed for most of the year by tech giants such as Nvidia Corp. that led the market surge. However, amid the so-called great rotation, big tech took a backseat and smaller companies began rallying significantly.
Subsequently, everything was revalued once again in recent days following a disappointing July jobs report that reignited concerns about the US economy’s well-being. Market sell-offs occurred at the beginning of last week, impacting equities, gold, and cryptocurrencies. Although the markets stabilized as the week progressed, the Russell 2000 closed the week with a 1.4% decline, marking its second consecutive weekly drop.
In a recent note, strategists at Bespoke Investment Group noted, “One thing is certain, investors have become increasingly worried over the past few weeks.”
Amid the market turbulence, funds were also pulled out from other risk-on areas. The iShares iBoxx High Yield Corporate Bond ETF (HYG) saw a $1.5 billion outflow last week, while the iShares MSCI Emerging Markets ETF (EEM) experienced nearly a $1.2 billion withdrawal, the largest since October. In contrast, larger-cap indexes fared relatively better than the small-cap index, with the S&P 500 closing the week relatively unchanged.
Roxanna Islam, head of sector and industry research at VettaFi, remarked, “While the market seems poised for a shift towards small caps, recent weaknesses in labor market indicators have increased uncertainty about the economic outlook, prompting investors to stick with large caps.”
