Small American stocks have tumbled into a big hole, reflecting mounting slowdown fears on Wall Street.
The Russell 2000 index of small-cap stocks plunged into a bear market on Monday, reflecting a 20% decline since hitting a record high in late August.
That marks the first bear market for the index since the downturn that spanned June 2015 to February 2016, according to Bespoke Investment Group.
The Russell 2000’s downfall is significant because the index is viewed as a barometer for confidence in American growth. The index contains 2,000 smaller companies that do little business overseas, making them highly exposed to swings in the domestic economy.
“Investors are showing real caution about the pace of economic growth for the US next year,” said Nicholas Colas, co-founder of DataTrek Research. “Confidence is falling.”
The broader markets are also down sharply, but they’ve so far avoided bear territory. The Dow declined 508 points on Monday, leaving it down about 12% from the record set in early October.
“People are looking to take any upside move as an excuse to get out,” said Paul Hickey, co-founder of Bespoke.
Small-cap stocks sometimes lead the broader market, making a Russell 2000 bear market a potentially ominous event. However, Hickey noted that this would be the Russell 2000’s third bear market since US stocks bottomed during the Great Recession in March 2009. The S&P 500 avoided a bear market during those other two downturns for small cap stocks.
Debt, trade war worries
The slide reflects concerns about rising borrowing costs during a potential economic slowdown.
About 40% of the debt held by Russell 2000 companies is floating-rate, according to Peter Boockvar, chief investment officer at Bleakley Advisory Group. The cost to service that debt has climbed in tandem with the Federal Reserve’s two-year stretch of raising interest rates.
“That’s a potential stress if growth is slowing in the United States, which the markets are betting on,” said Boockvar.
Further, Boockvar said that about one-third of Russell 2000 companies are unprofitable. That number could rise if the US economy stumbles.
PIMCO estimates that the odds of a US recession over the next 12 months have climbed to about 30%, the highest level during the nine-year economic expansion.
The Russell 2000 climbed 13% last year as investors bet that US-focused companies would avoid getting caught in the middle of trade wars. Multinational companies like Nike (NKE), Apple (AAPL) and Boeing (BA) dominate the S&P 500 and Dow.
“This was considered to be a safe haven,” said Colas. “But it ended up being a very crowded trade. And we know what happens to a crowded trade when the tide goes out.”
Boockvar said the idea that smaller companies would avoid the fallout of the crackdown on trade was flawed in the first place.
“That was idiotic. Small-cap stocks do business with big-cap stocks,” said Boockvar.
