According to the news report by Bloomberg, Citigroup Inc. says that the small-cap stocks, which have been mostly protected from the ongoing trade war between the US and China, could be in trouble as interest rates go up. Analysts at the bank say that the downward slide has already started.
The Russell 2000 index, which tracks the movement of small cap companies, dropped by 0.8% in Wednesday’s trading. The index has been declining for 5 consecutive days, a decline which has wiped out all the year-to-date gains for the second time in the last two months.
The index is already down by 14% since its peak in August and its current decline is double that of what the S&P 500 has experienced in the same time period. This is deviation from the first 8 months of 2018, when the Russell 2000 was ahead of its bigger counterparts by nearly 5%.
According to analysts at Citigroup, the fundamentals are now going against the small-cap companies. Increasing interest rates have already impacted the larger cap firms, which have lowered their earnings estimates. And small-cap companies are much more vulnerable to changes in interest rates, thanks to the fact that they have less leverage than the bigger companies.
Citigroup’s chief strategist for the US, Tobias Levkovich wrote in a note to clients that small cap companies’ weakness has now been justified. He also stated that Citi did not believe another inflection was possible in the short term that would buffer up the Russell 2000 over the S&P 500.
Citigroup analysts are not the only ones that are pessimistic about the fate of the small-cap companies. This sentiment has been echoed by strategists at the Bank of America, who have been cautious about small-caps despite the fact that this is the group’s highest discount in the last 15 years. BoA analysts are justifying their stance due to the decline in analyst revisions as well as corporate forecasts.
For a larger part of this year, investors have been bullish about small-caps because of their supposed insulation from all the turmoil in the world caused by the trade war. However, throughout this time, both Citigroup and BoA have been cautious about that bullish sentiment.
Data compiled by Citigroup shows that while the small-cap index is at 75%, the Russell 2000’s exposure to sales in the North American region is not that distanced from the 72% to 72% observed in the large cap companies.
It has been noted that despite the so called protection from the trade war, the small cap companies have shown the same amount of concern over trade. In fact, studies conducted by the Bank of America reveal that the word “tariff” was mentioned almost the same number of times during earnings calls for both the small- and large-cap companies.
BoA’s head of equity and quantitative strategy, Savita Subramanian wrote in a note to clients on Monday that concerns and anxiety around tariffs are high throughout the cap spectrum.
Bloomberg wasn’t the only news agency to highlight the dangers facing the small cap market. CNBC reported that small cap companies just entered a “death cross” pattern. This type of chart pattern implies that there is going to be a big down-turn in the market.
The report shows that the Russell 2000’s 50-day moving average dropped below the 200-day moving average. This is what is known as the “death cross” pattern. The index has seen widespread selling since October.
The last time the Russell 2000 witnessed a death cross pattern was in 2015, when it plunged by 17%.