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Small Caps Could Surge When This Is Over By Spencer Jakab

Markets staged a brief, $2 trillion bounce yesterday on a false tariff headline . Today, stock futures are pointing to a rebound on hopes we'll get a real breakthrough soon. That is despite China's vow to " fight to the end ."

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The market's plunge is a lesson in FAFO . Are we about to get one in FIFO?

This is a PG-rated newsletter so we won't spell the first acronym, but the second is a term from accounting-first in, first out-that also applies to stocks. When Americans talk about "the market" they generally mean the large companies that make up the S&P 500. That's a decent proxy for corporate America, but there are a few thousand stocks below that level that act differently and are occasionally lucrative to own.

Not at the moment, though: The leading small-stock index, the Russell 2000, entered a bear market last week. Large stocks have been on the cusp of joining them almost immediately thanks to the "Liberation Day" panic, but this isn't the typical pattern. Small caps usually have been an early-warning indicator of trouble in the economy and for the rest of the market.

For example in July 2007, when the financial crisis was just gathering steam and analysts mostly had "buy" ratings on big banks, the Russell 2000 peaked. The index entered a bear market in January 2008, two months before the Bear Stearns rescue. The S&P 500 didn't do those things until three and six months after the Russell did, respectively.

That sounds like something of purely academic interest for investors sobbing over their stock portfolios today, but there's a profitable upshot: Small stocks are both first in and first out-and they exit severe bear markets with a bang.

Following the end of the tech bust, financial crisis and Covid-19 bear markets, they entered a new bull market sooner and had a total return, on average, of 90% in the 12 months following the market bottom-30 percentage points more than the S&P 500.

Why? Small companies tend to be more fragile than larger ones and have less access to financing, relying more on bank loans than bonds. When risk appetite improves, their investors breathe that much more of a sigh of relief.

Small caps may be especially weak today. A decade-and-a-half of cheap money fueled a wave of buyouts by private equity and by larger companies. With so many attractive businesses snapped up, the current companies making up the Russell 2000 are junkier . And since membership is based purely on size on a given day, some companies that have no business being part of a widely held stock benchmark sneak in.

Yet the Russell 2000 Value Index, which suffers less from that issue and holds more profitable companies, has been especially neglected. Since the beginning of 2015, the S&P 500 has produced three times its total return. The S&P 500 trades at around a two-thirds premium to that value index on the basis of its trailing price-to-earnings ratio.

The gap could widen if we're entering a recession, but watch this space when the end seems to be in sight.

Stocks I'm Watching

U.S. Steel : The Trump administration said it ordered a new review of Nippon Steel's proposed takeover of the iconic U.S. manufacturer after it was blocked during the Biden administration. The stock surged Monday and is up again in premarket trading.

United Airlines : One of last year's hottest stocks turned ice cold as fewer people want to fly the friendly skies-particularly foreigners, who have canceled U.S. visits. Americans are cutting back too. Between Inauguration Day and Friday the stock was down 48% but it inched into positive territory Monday and looks like it could rise again.

Rheinmetall : How much has the world changed? This time last year the world's hottest stock was U.S. chip maker Nvidia. Today it's a German weapons manufacturer. After slipping for two days amid broader market turmoil, the stock jumped Tuesday in European trading, bringing its gain so far in 2025 to around 114%.

Levi Strauss : Chief Executive Michelle Gass said the jeans maker will be "surgical" with any price hikes , rather than making across-the-board changes in response to tariffs. Shares jumped 13% ahead of the open.

Toyota Motor : The carmaker was a winner, as Japanese markets rallied on hopes Tokyo could negotiate lower tariffs with the U.S. Tech investor SoftBank and semiconductor company Tokyo Electron also jumped.

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How Mexico Emerged From Tariff Attack With an Edge Over Asia

President Trump's first round of tariffs and trade threats threw Mexico onto the defensive. Now that Trump is aiming at the rest of the world, Mexico suddenly finds itself with an edge over rival manufacturing hubs.

What I'm Reading What's the White House's latest stance on tariffs? It depends whom you ask, with some officials saying Trump is open to negotiations and others contradicting them. It's all adding to the chaos. ( WSJ ) For weeks, business leaders have avoided voicing concerns about tariffs. Some executives are getting more vocal. ( WSJ ) Americans have built up $35 trillion in housing wealth. It's costing them. ( WSJ ) Not everyone is hurting: Medical insurers offering private Medicare plans are getting a bigger boost next year from the government than what had been indicated under the Biden administration. It exceeded analysts' most optimistic estimates. ( WSJ ) Here's the iPhone with all its components shown. And here's the costlier version with tariffs. ( WSJ ) Beyond the Newsroom

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About Me

My name is Spencer Jakab and I've been musing about money and markets for more than 30 years, including editing The Wall Street Journal's Heard on the Street column for a decade, writing two investing books and running a team of stock analysts at a global investment bank.

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This article is a text version of a Wall Street Journal newsletter published earlier today.

(END) Dow Jones Newswires

April 08, 2025 06:45 ET (10:45 GMT)

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