This week, something interesting happened in the market. The big-name tech stocks, the so-called “Magnificent 7”, took a breather, and small-cap stocks jumped in to take the lead. The Russell 2000, which tracks smaller companies, climbed about 2% on Wednesday.
For the week so far, it is already up almost 5%, making this its best run since last November.
What’s behind the move? Investors are betting that the Federal Reserve will start cutting interest rates in September. Lower rates make it cheaper for companies to borrow money, which is a big deal for small businesses that often rely on loans to grow.
Rate Cuts Will Supercharge Small Caps
Small caps react more to rate changes than big companies. They usually have higher borrowing needs and more domestic-focused businesses. That means when rates drop, they can expand faster, and local consumer spending can give them an extra boost.
Right now, the odds of a September rate cut are almost 100%, according to the CME FedWatch tool. Just a month ago, those odds were under 60%.
We saw weaker job growth in July, downward revisions to earlier labour data, and an inflation report that came in cooler than expected. This made investors more confident that the Fed would act to support the economy.
Some small-cap names are already seeing big gains. Chemours and Hillenbrand both jumped over 12% in a single day. Dream Finders Homes rose 13%, while Jack in the Box climbed 12%.
The Bigger Picture for Investors
Small-cap stocks are coming off their first earnings growth in over a year. Analysts at Bank of America think they could keep outperforming in the second half of 2025.
They point to factors like cheaper valuations compared to large caps, less investor money currently in the sector, and potential benefits from reshoring, bringing more manufacturing back to the U.S.
Still, it’s worth noting that small caps have lagged behind big tech for years. Since late 2022, the Russell 2000 is up less than 26%, while the S&P 500 has surged 64%.
That’s why this recent rally feels like a shift in market leadership, even if there’s still ground to make up.
If rate cuts do start next month, it could mark the beginning of a longer run for small-cap stocks. For investors who’ve been watching from the sidelines, now might be the time to pay closer attention.
