Small-caps are under pressure after outperforming the S&P 500 earlier in the year. They could be an important bellwether going forward.

Small-cap stocks are down in the third quarter through Tuesday, putting the Russell 2000 on track for its first quarterly loss since the first three months of 2025, according to FactSet data.

Small-capitalization stocks are back in the market's spotlight after sliding below a key chart level, as investors watch for signs that rising global bond yields could put more pressure on equities.

Small-cap stocks tend to be more sensitive to rate changes, the thinking goes. So if these stocks start to stumble over higher borrowing costs, it could be an early sign of pressure building in the broader U.S. equity market. Smaller companies tend to be more reliant on debt to fund operations, particularly of the variable-rate variety, than their larger-cap counterparts.

After dramatically outperforming their larger peers earlier in the year, the small-cap Russell 2000 Index RUT has started to struggle in recent weeks, while other indexes like the S&P 500 have mostly traded sideways. The Russell 2000 includes nearly 2,000 of the smallest companies, with an average market capitalization of about $1.9 billion, compared with an average market cap of $146.2 billion for the S&P 500 components, according to FactSet data.

The Russell 2000 was falling again on Wednesday, adding to its recent decline after falling below the closely watched 50-day moving average late last month, according to FactSet data. A break below the key threshold, which is seen as a guide to the shorter-term trend, could signal more pain ahead for the index.

The index has lost ground so far since the start of the third quarter, putting it on track for what would be its first quarterly loss since early 2025, according to Dow Jones Market Data.

FACTSET

Stocks continued to struggle on Wednesday as crude oil prices and Treasury yields built on recent gains. The CME's FedWatch Tool on Wednesday showed traders in the fed-funds-futures market were pricing in a roughly 62% chance the central bank may decide next week to raise its policy rate.

The S&P 500 SPX, a major index of U.S. large-cap stocks, was also falling on Wednesday, approaching its 50-day moving average, FactSet data show.

FACTSET

While the Russell 2000's recent fatigue may have some investors on edge about broader-market worries over the future path of rates set by the Fed in the face of sticky inflation, there are still reasons for optimism. Like their larger peers, small companies have benefited from expectations for strong earnings growth.

According to Brandon Nelson, a senior portfolio manager at Calamos Investments who focuses on small- and midcap stocks, signs of robust earnings growth helped fuel small-caps' outperformance earlier in the year.

The latest pullback could strengthen the case for a strong rebound rally heading into the end of the year, Nelson added.

"It wouldn't surprise me if we chop around here for another few weeks," Nelson said in a phone interview. "We're laying the groundwork for what's probably going to be another fourth-quarter rally," he said, adding, "I'm still pretty upbeat about the fundamentals."

Recent history bodes well for stocks in the final three months of the year.

Over the past 20 years, the Russell 2000 has outperformed on average both the S&P 500 and another measure of U.S. large-cap stocks, the Russell 1000 Index RUI, in the fourth quarter, according to Dow Jones Market Data. Looking further back, the three indexes had similar positive gains on average in the fourth quarter since 1987, as the table below shows.

DOW JONES MARKET DATA

Meanwhile, the small-cap-focused Russell 2000 Index has rallied 18% this year, as of morning trading on Wednesday, while the S&P Small Cap 600 Index SML has climbed 18.2% - each easily beating U.S. large-cap equities stocks measured by the S&P 500 and the Russell 1000, which are up 11.4% and 11.3%, respectively, on the year.

There are plenty of worries in the stock market ahead of the fourth quarter, said Nelson, as the Iran conflict persists and traders anticipate the Fed will weigh a potential rate increase to help bring down inflation to its 2% target.

But a Fed rate increase in September probably wouldn't be the start of an aggressive rate-hiking cycle, he said, adding that the central bank raising its policy rate by a quarter of a percentage point doesn't seem enough to cause the stock market to "freak out."

"We're not defensively positioned," Nelson said. "I think we're setting up to make a big run in the fourth quarter."

-Christine Idzelis