Investors watching the S&P 500’s plunge this week are processing a mix of signals. Will the threat of tariffs push the economy into a recession or is this simply a retrenchment from the highly valued technology companies that some analysts and investors argued were due for a pullback?
There is a different stock index that is flashing a clearer warning sign.
The Russell 2000 includes smaller companies that are more sensitive to the whims of the economy. These companies tend to run thinner profit margins that can be more easily eroded in a downturn, and they have fewer levers to pull than big companies if they do get into trouble.
After surging to a new high in November on optimism about the new Trump administration’s pro-business policies, the Russell 2000 has tumbled more than 18 percent, roughly double the decline of the S&P 500 since it hit a peak last month.
The Russell 2000 now appears likely to become the first major index to slip back into a bear market, defined as a drop of 20 percent or more from its recent high, since the stock market sell-off in 2022.
“If you want one clear signal that the market is worried about recession more than anything else, then look at the Russell,” said David Kelly, chief market strategist at J.P. Morgan Asset Management.
Continual policy pivots from the administration on tariffs have left investors uncertain about what is to come and how the economy may be affected.
Even if tariffs are eventually rolled back, uncertainty in the meantime can still prompt businesses to rein in hiring and pull back spending, slowing the economy.
And there are signs that businesses are growing weary, with airlines warning about declining air travel, retailers warning about consumer spending and food companies warning about rising prices.
And it’s not just tariffs that investors are facing. Rapid cuts to the federal work force and an abrupt halt to other government spending projects also risk slowing the economy.
“We are already seeing the impact of a reduction in government spending, and I expect that to continue,” said Kristina Hooper, chief global market strategist at Invesco.
The plant-based food company Beyond Meat, which is part of the Russell 2000, warned in its latest financial report that tariffs, as well as countermeasures by other countries, could lead to price increases. The company also cautioned that it could lose customers abroad because of “anti-American sentiment.”
On Tuesday, the National Federation of Independent Business’s monthly survey of small-business optimism fell for the second consecutive month, and the group’s measure of uncertainty rose to one of its highest levels on record.
On Thursday, the S&P 500 fell into correction territory, which is defined as a decline of 10 percent or more from an index’s recent peak.
But the signals coming from the S&P 500 can be muddied by its composition.
The ballooning size of the technology sector, led by companies like Apple and Nvidia, means the index is more dependent on the ups and downs of these behemoths than any others.
The Magnificent 7 stocks — the name given to the seven big tech companies that have led the stock market higher in recent years — now account for roughly 30 percent of the S&P 500’s entire valuation.
The tech sell-off in recent weeks probably represents concerns for the broader market, said analysts, but it could also be part of changing expectations of the profit potential of artificial intelligence, or even just a step back after a dramatic rise in valuations in recent years.
That run-up had left the market “priced for perfection,” said Mr. Kelly, meaning every company would have to have the best possible outcomes. “And this is not perfection,” he added.
The Russell 2000 index is not overly concentrated on one sector of companies. The largest company in the index, Sprouts Farmers Market, represents just 0.5 percent of the index’s total valuation, while Apple, the largest stock in the S&P 500, carries a weight of over 7 percent, far more than the top 10 stocks in the Russell 2000 combined.
Adjusting the S&P 500 to give every stock equal weight further illustrates the effect of the tech sell-off, taking the index’s drop this year from over 6 percent to 2.6 percent.
Doing the same for the Russell 2000 only slightly changes its roughly 10.5 percent drop this year. The tech sector isn’t even the largest in the Russell 2000, with financial, industrial and health care stocks all making up a larger portion of the index.
What this means is that the signal coming from the Russell 2000 more clearly points to broader worries beyond an overvalued tech sector that was already primed for a decline, analysts say.
The Russell 2000 index is also more domestically focused. Roughly 30 percent of the revenues for the S&P 500 come from outside the United States, double that of the Russell 2000. And international stock markets have comfortably outperformed U.S. equities so far this year.
“I think what the Russell is telling us is that there is real concern about the economy,” Ms. Hooper said.
Content Source: www.nytimes.com