Why Small-Cap Stocks Slid Further Into Correction Territory on Monday

Small-cap stocks fell further into
correction territory
on Monday as equities continued to stumble amid heightened economic uncertainty.

The
Russell 2000
was down 0.3% in recent trading, after falling more than 1% earlier in the session. The small-cap benchmark index is down 10.3% from its record close of 2,442.03 in late November.

Small cap stocks
soared
in the wake of Donald Trump’s election victory, with the Russell 2000 jumping nearly 6% the day after his re-election. Trump’s deregulatory, pro-growth agenda was expected to boost sales and lower expenses for smaller companies and unleash a flurry of acquisitions. Instead, uncertainty around interest rates, tariffs, and consumer demand have weighed on the group.

“Overall, sentiment has been cautiously optimistic, but many worry about lack of a catalyst … to spur small cap outperformance amidst rate/policy uncertainty and elevated valuations,” wrote Bank of America analysts in a note on Monday.

Fourth-quarter earnings season hasn’t boosted investor confidence in small caps. While profit has so far slightly exceeded expectations, it remains flat year-over-year and analysts have lowered their estimates for the next 12 months. And a BofA analysis of earnings calls suggests small-cap corporate sentiment is deteriorating.

The deregulation Trump promised on the campaign trail could still benefit smaller companies and their stocks. However, Trump’s trade protections could eat into earnings and encourage the Federal Reserve to
keep interest rates elevated
, a major
headwind for small caps
, which tend to carry more floating-rate debt.

Another headwind for small caps: stubborn inflation. Consumer price inflation
accelerated
for the fourth consecutive month in January, suggesting the Fed’s progress on bringing annual inflation back down to 2% may have stalled. Investors have
lowered their expectations
for further interest rate cuts this year.

Higher interest rates may also dampen
M&A activity
, somewhat offsetting the benefit from a more relaxed regulatory environment. Most of the factors that drive M&A, like the growth backdrop, are supportive of acquisitions, BofA said. Though they predict deals will benefit select sectors—like health care, tech, and finance—more than the Russell 2000.

Read the original article on
Investopedia