Some signs of the U.S. economy’s trajectory, including consumer sentiment plunging to a two-year low, U.S. stocks sinking and President Trump’s foreign trade policy creating a climate of uncertainty for U.S. businesses, are pointing downward. There’s also another, less-closely watched index that is showing signs of trouble ahead.
The Russell 2000, a stock index made up of small companies, is down more than 18% since its peak in November when Mr. Trump was elected. The index initially rose on optimism that the new administration would create a more business-friendly environment, but that sentiment has changed amid an escalating trade war with some of the U.S.’s closest allies. Mass federal layoffs initiated by the Department of Government Efficiency, or DOGE, have also created tremendous uncertainty for businesses.
Now, the small-cap index is headed toward a bear market, defined by a decline of 20% or more from its most recent high.
“Some small caps like the Russell 2000 were outperforming the S&P 500 after the election, presumably on the theory that there was going to be substantial deal activity, because these companies are more likely to be acquired and merge than the largest of the large-caps,” Daniel Hornung, former deputy director of the National Economic Council, told CBS MoneyWatch.
“There was a sense that there was going to be deregulation and easier environment for transactions to occur, but there’s a huge amount of uncertainty hanging over the economy and markets right now that makes it really difficult for transactions to happen,” Hornung explained.
Broad-based tariffs on Mexico, Canada and China, plus 25% levies on steel and aluminum threaten to raise costs for both businesses and consumers. Smaller companies with tighter profit margins have a harder time absorbing greater input costs compared to larger ones.
Canary in the coal mine
The Russell 2000 comprises small companies across a variety sectors, and is widely considered to be a benchmark for small U.S. stocks. Unlike the tech-heavy S&P 500, it is not weighted toward a particular industry.
Small companies are more exposed to market shocks than larger ones, given that they operate on thinner margins and typically have higher borrowing costs, making the index more sensitive to changes in the economy.
“It’s more diversified at the sectoral level, so it is more representative of U.S. growth dynamics,” Skanda Amarnath, a macroeconomist and executive director of Employ America, told CBS MoneyWatch.
Some of the Russell 2000 companies include commercial jet engine company FTAI Aviation, grocery chain Sprouts Farmers Market, plant-based food company Beyond Meat, and language learning tool Duolingo.
Not pointing to a recession
While the Russell 2000 is only two percentage points away from entering bear market territory, Bank of America Research economists say it’s not pricing in a recession, and they still expect the economy to grow this year.
“Historically in recessions the Russell 2000 has sold off close to 40% on average,” said Jill Carey Hall, head of U.S. small- and mid-cap strategy at Bank of America Research. “So it’s not pricing in greater than a 50% probability of a recession at this point.”
Still, small businesses could face significant profit margin erosion with tariffs in place.
Based on the levies currently in place on Canada, Mexico and China, and assuming retaliatory tariffs, Bank of America estimates that the earnings hit could be three times larger for small caps than for large caps.
“These companies have much thinner margins, so a rise in input costs hurts them more,” Carey Hall said.
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