What had been touted as Wall Street’s big rotation into smaller firms sputtered just as quickly as it started.
The same stocks that were for weeks finally seeing greater investor interest are now suffering a mass exodus as investors recalibrate their expectations for US economic growth. Amid a rocky week for equities, traders pulled $2.6 billion from the iShares Russell 2000 ETF (ticker IWM) in the five days through Friday, the most in nearly three years, according to data compiled by Bloomberg. And many are betting that the worst of the selloff lies ahead — short interest as a percentage of shares outstanding on the fund has spiked to its highest level since December, according to data from IHS Markit Ltd.
The pullout follows a stretch when traders had been showering money on previously left-for-dead strategies that saw the Russell 2000 — IWM’s underlying index — rise 10% in July, the biggest monthly gain since the end of last year. The gauge is now off by roughly 8% for August, with the decline coming as many start to fret over the health of the US economy and the Federal Reserve’s ability to bypass a recession.
“The trading crowd is getting the hell out of small caps,” Eric Balchunas at Bloomberg Intelligence said on X. “It was fun while it lasted (for like two weeks).”
Investors had — at least for a few weeks in July — gotten excited over small-caps firms, betting that a coming era of lower interest rates, among other factors, would be beneficial. The cohort had previously been shunned for much of the year in favor of the tech behemoths, like Nvidia Corp., that powered the market higher. But big tech took a back seat amid the so-called great rotation, while smaller counterparts started to rally in earnest.
Then all of it got repriced once again in recent days after a weaker-than-expected July jobs report reignited fears over the health of the US economy. At the start of last week markets sold off, with everything from equities to gold to cryptocurrencies sliding. Though calm returned as the week progressed, the Russell 2000 ended the week down 1.4%, its second weekly decline in a row.
“One thing for sure is that investors have gotten more worried over the last few weeks,” strategists at Bespoke Investment Group wrote in a note.
Amid the turbulence, traders also yanked cash from other corners of the market that tend to benefit during risk-on phases. 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) notched a nearly $1.2 billion withdrawal, the most since October. Meanwhile, larger-cap indexes held up better relative to the small-cap gauge, with the S&P 500 ending the week little changed.
“While the market seems overdue for a shift into small caps, recent weakness in labor market indicators has created more uncertainty about the economic outlook and kept investors clinging to large caps,” said Roxanna Islam, head of sector and industry research at VettaFi.
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