Amid banking woes, faltering US small-caps offer ominous economic sign

A U.S. stocks rally is leaving behind smaller companies, a sign that investors may be bracing for economic turmoil ahead.

The small-cap Russell 2000 is down about 1% this year, compared to a rally that has boosted the S&P 500, an index representing the largest U.S. companies, 7% year-to-date.

Like the inverted U.S. Treasury yield curve and strength in gold prices, the weakness in shares of smaller companies – which tend to derive profits domestically and be more vulnerable to economic shifts than larger firms – is one of several signs that investors are uneasy about the economic outlook.

Small cap stocks have struggled since turmoil in U.S. regional banks erupted in early March, with the Russell 2000 down 7% since March 8. Investors fear that smaller firms will be hit hard by a potential lending slowdown that could weigh on the broader economy.

Investors are “trying to position their portfolios for what they think is going to happen in the economy,” said Eric Kuby, chief investment officer at North Star Investment Management, which specializes in small caps. “Small caps being out of favor is another signal that investors are bracing themselves for an impending recession.”

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