Even worse, the Russell 2000, one of the most commonly used benchmarks for small-cap stocks, has officially entered bear market territory. It has since had a dramatic 20% drop from its ATH close in late November 2024. New tariffs and extreme economic pressures from the pandemic are pushing this decline. All three are expected to pinch profit margins for firms that are most dependent on imported goods.
A number of these big names — Victoria’s Secret and Urban Outfitters, for example — have already come under downward pressure in the midst of these economic headwinds. Both retailers are deeply dependent on foreign suppliers for most of their products. This reliance on foreign products makes them particularly susceptible to the skyrocketing costs imposed by tariffs. Industry analysts estimate these tariffs will more than halve profit margins for their companies. This shift would make very challenging market conditions even more difficult.
Keith Lerner, co-chief investment officer at the wealth management arm of Truist, pointed out the two-sided influence of these economic dynamics.
“They’re getting hit because the economy is softening. That’s going to hurt profits,” – Keith Lerner.
Traders are looking for Federal Reserve interest rate cuts. At the same time, the Russell 2000 is in a deep bear market. If the central bank does cut rates later this summer, that would be a huge relief for small-cap stocks. Right now, there’s a 58.5% chance that the Fed will do four quarter-percentage-point cuts by the end of 2025. In addition, more than 90% of market participants expect the next cut to be at the Fed’s June meeting.
Even with all of these potential positive headwinds, the small cap outlook is decidedly mixed. In a note sent to clients this week, Steven DeSanctis, an equity strategist at Jefferies, highlighted the historical record of small-cap stocks when the U.S. economy slows.
“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,” – Steven DeSanctis.
Small-cap stocks are trading near an important line in the sand at the moment. Historically, they’re inclined to fall by an average 26% in bear markets. With that, the Russell 2000’s current trajectory would mean it could beat it to that number.
A remarkable resilience is displayed on the wider S&P 500 index. At the time of writing, it sits more than 11% below its recent high from February 19, indicating that it’s in correction territory but not yet a bear market. This separation, perhaps unintentionally, raises the very real concern about the different challenges that small-cap companies have to their larger brethren.
Fears for the health of the U.S. economy have grown in recent weeks, especially as President Donald Trump has started rolling out reciprocal tariffs. JPMorgan analysts have warned that if these tariffs remain in place, they could push the U.S. economy toward a recession. In March, the Russell 2000 approached bear market territory amidst a monthlong sell-off driven by uncertainty over tariff policies and growing fears of an economic slowdown.
Investors remain vigilant as they monitor economic indicators and potential policy shifts from the Federal Reserve. The one-two punch of increased tariffs and slowed economic growth will likely continue to put pressure on small-cap companies in the months ahead.
“They’re getting squeezed on both sides,” – Keith Lerner.
Investors remain vigilant as they monitor economic indicators and potential policy shifts from the Federal Reserve. The combination of rising tariffs and muted economic growth is expected to challenge small-cap firms in the near future.