Small-cap stocks have lost momentum as higher interest rates weigh on companies with greater financing needs. Small caps also lagged year to date, returning 14. 3% compared with 15. 1% for the S&P 500, and entered correction territory during the latest decline.
Wells Fargo Investment Institute maintained an unfavorable view of U.S. Its analysts said earlier gains had been driven largely by speculative, unprofitable companies in artificial intelligence, semiconductors and biotechnology, along with expectations earlier in the year for Federal Reserve rate cuts.
Small-cap companies generally carry more debt, have less access to capital markets and rely more heavily on short-term or floating-rate borrowing. About 40% of rate-classified debt among Russell 2000 companies are floating rate, nearly five times the comparable share for the S&P 500, leaving smaller firms more exposed to changes in borrowing costs. The institute also cited higher labor-cost sensitivity, limited pricing power and narrower capital buffers as factors that may constrain earnings visibility.
Market pressure continued after the five-week slide. The Russell 2000 remained up 12. 6% for the year at that point, versus a 14% gain for the S&P 500.
The broader backdrop has become less supportive for rate-sensitive companies.
The institute remained overweight equities relative to fixed income and said it would favor buying on meaningful pullbacks. Within equities, it was neutral on Information Technology because of stretched valuations and rising debt-funded capital spending, favored Communication Services, Industrials and Materials, and remained cautious on rate-sensitive Real Estate.