Small-cap stocks are smoking the S&P 500. Bond yields may hold the key.

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By Christine Idzelis

The Russell 2000 rose sharply Monday, beating the S&P 500

Small-cap stocks are on a tear this month, as investors question the sustainability of the rally and the future path of interest rates after President-elect Donald Trump enters the White House in January.

The Russell 2000 Index RUT, a gauge of U.S. small-cap equities, climbed a sharp 1.5% Monday, while the S&P 500 SPX edged up 0.1% to notch a fresh record high. The jump in small-cap stocks on Monday – and last week – easily outperformed the rise in the S&P 500, a widely followed U.S. large-cap stock gauge.

“Market momentum remains strong,” Louis Navellier, chief investment officer at Navellier & Associates, said in emailed commentary Monday. “While valuations are getting challenging compared to historical averages, it is being expressed by bidding up underperforming sectors for now,” exemplified in part by the Russell 2000 “handily outperforming” the S&P 500, he said.

Navellier pointed to investors’ “fear of missing out” on stock-market gains.

Jefferies analysts said in a note Saturday that the question they were “most interested in solving” is whether small-cap stocks will “keep working” after their rally on the election results.

“Clearly a path to lower rates will have something to say about it, but the investor community appears to have voted with their feet on Wednesday,” the analysts said.

Small-cap stocks surged last week as long-term Treasury yields retreated.

The yield on the 10-year Treasury note jumped after Trump won the race for the White House and a Republican sweep in Washington appeared likely, with investors appearing to price in worries over his tariff policies increasing inflation and a potentially larger fiscal deficit.

But the 10-year Treasury yield – an interest rate used by investors to value stocks – ended the week lower, as investors also assessed Federal Reserve Chair Jerome Powell’s remarks after the Fed’s rate decision on Nov. 7.

“Fed Chair Powell didn’t outright commit to lowering rates quickly,” the Jefferies analysts said. “Some on the Street are starting to back out rate cut expectations for ’25,” they wrote, adding “that is probably going to put a bit of a focus premium on the inflation data that we get over the next several months.”

The bond market was closed Monday in observance of Veterans Day.

The 10-year Treasury yield BX:TMUBMUSD10Y fell 5.4 basis points last week to 4.307% on Friday, snapping its seven-week rising streak, according to Dow Jones Market Data. As for shorter-term rates, the yield on the 2-year Treasury note BX:TMUBMUSD02Y rose 5.2 basis points last week to 4.253% on Friday.

Ahead of the election, Treasury yields recently climbed on surprisingly strong economic data and betting markets pointing to a higher probability of a Trump win, according to John Madziyire, senior portfolio manager and head of U.S. Treasuries and TIPS at Vanguard Group.

A “knee-jerk reaction” on the day of the election results then sent yields higher, he said by phone. It made sense to see the market subsequently “retracing back,” according to Madziyire.

“We’re now at the next stage,” he said. “For us, to get yields higher from here, we have to have a strong view” of Trump’s prospective policies, including more tariffs, “actually being implemented.”

Meanwhile, the Russell 2000 is up almost 11% just this month through Monday, beating the S&P 500’s 5.2% climb in November, according to FactSet data.

“Our suspicion is that even though lower interest rates would help further catalyze the move, we are probably in a bit of a regime shift in the intermediate term,” the Jefferies analysts said of small-cap stocks.

Their research found that when the Russell 2000 “pops hard against its bigger sibling,” the S&P 500, small-cap performance “tends to stay strong.” The outperformance of the Russell 2000’s five-day return measured on Nov. 6 was a more than 3-standard-deviation event, they said.

The analysts looked at the spread in five-day returns for the Russell 2000 versus the S&P 500 based on data going back to 1980 and found that the small-cap index has historically averaged an almost 7% return over the following six months and a 12-month gain of 14%.

Read: Fate of postelection stock-market rally may be in the hands of bond traders

The U.S. stock market closed higher Monday, with the S&P 500 ending above 6,000 for the first time. The Dow Jones Industrial Average DJIA finished Monday with a 0.7% gain while the Nasdaq Composite COMP edged up 0.1%.

While equities have broadly rallied on “the potential for a broadening of economic strength” on expectations for pro-growth policies under Trump, small-cap and mid-cap stocks in the U.S. are “two areas of the market we have identified as historically cheap relative to their large-cap counterparts,” said Brent Schutte, chief investment officer at Northwestern Mutual Wealth Management Co., in a note Monday.

-Christine Idzelis

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11-11-24 1758ET

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