Russell 2000 Posts Best Day Since August as Small Caps Jump 1.65% on Falling Yields and Broad Market Rotation

NEW YORK — Small-company stocks had their best day in more than two months Tuesday. Investors shifted money out of large technology companies, and falling long-term Treasury yields gave a lift to rate-sensitive stocks.

The Russell 2000 index of smaller U.S. companies rose 45.12 points, or 1.65%, to 2,773.42. It was the index's best day since early August, and it outperformed all the other major U.S. stock indexes.

By comparison, the S&P 500 rose 0.3%, the Dow Jones Industrial Average gained 1%, and the Nasdaq composite ended almost flat. Early Wednesday, Russell 2000 futures were slightly lower before the opening bell, while the larger indexes moved higher on a rebound in AI stocks.

A broad rally

Tuesday's gains were spread widely across the market. An equal-weighted version of the S&P 500, which gives every company the same importance regardless of size, rose more than 1%. That was nearly a full percentage point more than the standard S&P 500, which is dominated by a handful of big technology companies.

Health care led the gains, and real estate and utilities also did well. Technology was the weakest area.

Strategists have been watching for signs that more of the market would join the rally. "If you look at the breadth of the market, it's been terrible," Morgan Stanley's Mike Wilson said on CNBC on Tuesday. Tuesday's session was one of the strongest broad-based days in weeks.

Yields and oil help

Small companies are often more sensitive to interest rates than large ones because they rely more on borrowing and floating-rate debt. That makes them especially vulnerable when Treasury yields rise.

On Tuesday, the 10-year Treasury yield fell 3 basis points to 5.12%, and the 30-year yield fell about 6 basis points to 5.42%. Long-term rates declined after weak housing data, including a report showing homebuilder confidence at its lowest level since 2012.

Oil prices also helped. Brent crude rose to nearly $112 a barrel early in the day, then fell back below $109, turning an early market decline into a broad gain. Lower energy costs ease inflation pressure and help many smaller, domestically focused companies.

A rough stretch for small caps

The rally comes after a difficult few months. The Russell 2000 hit a record close of 3,045.48 on Aug. 12. Since then, it has fallen about 9%, at times approaching a correction, which is usually defined as a 10% drop from a peak.

The selloff followed a sharp rise in borrowing costs. The 10-year yield climbed from about 4.68% in mid-August to more than 5.3% in early October. In September, the Federal Reserve raised interest rates for the first time since 2023, reversing hopes for lower rates that had fueled a strong small-cap rally from March to August.

The link between small-cap stocks and Treasury yields has been unusually strong. According to market analysts, the Russell 2000's recent negative correlation with yields is among the most extreme readings since 2003.

The pressure was clear in September, when the Russell 2000 fell more than 5% and ended the third quarter down about 7.5%. Even so, the index is still up about 12% this year.

Investors cautious

Not all investors were convinced. The iShares Russell 2000 ETF, one of the most popular small-cap funds, had about $1.1 billion in outflows before Tuesday's rally, suggesting many investors were still reducing their exposure.

The Federal Reserve remains the main risk. Traders expect the central bank to raise interest rates again by December, though a hike at the meeting later this month is seen as less likely. Any sign of a more aggressive Fed could hurt small caps again.

Oil is another risk. Brent crude rose back above $110 a barrel early Wednesday after Iran said its naval mines hit tankers in the Strait of Hormuz, a claim the U.S. military rejected. Higher oil prices could push up inflation and keep yields high.

What would sustain a rebound

Analysts say a lasting small-cap recovery will depend mainly on bond yields stabilizing or falling. Better third-quarter results from smaller companies would also help, as would signs that inflation is cooling enough to slow the Fed's rate increases.

Tuesday's gains showed how quickly small caps can rally when interest rate pressure eases. Whether the rally continues will depend on the Fed, oil prices and the bond market over the next few weeks.