U.S. Small Caps Gain Momentum as Bond Correlation Weakens
Over the past 60 days, the Russell 2000 has gained 6.6%, while the Russell 3000—which also includes large- and mid-cap stocks—has advanced only 2.8%. A gap of nearly four percentage points in just two months is a clear sign that something has changed in the behavior of U.S. small caps.
Our scores confirm this picture. The Russell 2000 currently carries a slightly positive profile, with a Health Score of 59.9 and a directional signal of +20. On its own, this is not an exceptional reading, but its significance becomes evident when compared with its peers: the S&P 500 stands at just 48.6, firmly in neutral territory. Within U.S. equities, the Russell 2000 ranks ahead of semiconductors (52.3), the broad U.S. market (48.6), and gold miners (41.7). Only the Dow Jones, at 62.9, scores higher. Small companies are outperforming large ones.
The outperformance of the past two months has not been linear. During the first two weeks, small caps actually lagged behind: while the broader index gained 4.1%, the Russell 2000 advanced only 2.6%. The turning point came in mid-May, and the complete reversal has taken place over the last four weeks. Since the end of May, the Russell 2000 has gained 1.7%, while the broader 3,000-stock index has declined 2.5%. It is not simply that small companies are rising—it is that they are rising while the rest of the equity market stalls.
To understand why, it is useful to step back and revisit the historical relationship between this segment and interest rates. U.S. small-cap companies rely heavily on bank financing with floating-rate debt: roughly 40% of the debt carried by Russell 2000 companies is floating rate, compared with less than 10% for the S&P 500. When rates decline—or when markets expect them to decline—the benefit to small caps is more direct and immediate than for larger companies. This is why the Russell 2000 has historically exhibited a positive correlation with government bond prices: both asset classes benefit from the same narrative, namely lower borrowing costs.
That relationship remained fully intact until early June. The 20-day correlation between the Russell 2000 and long-dated U.S. Treasuries reached 0.90, an exceptionally high level that suggested investors were buying both assets for the same reason. Since then, the correlation has steadily declined and now stands at 0.52. A drop of nearly 0.40 correlation points is a meaningful signal.
What has changed? Momentum has taken control. Within the KBMeter framework, Russell 2000 momentum deltas are positive across all three time horizons—short, medium, and long term. Such alignment is relatively rare and tends to be self-reinforcing. When a market segment performs well for structural reasons, capital flows begin to chase the trend, and those flows themselves become an additional driver. Investors are no longer buying small caps solely as a bet on Federal Reserve rate cuts—they are buying them because they are already moving higher.
Beneath this momentum, however, there are tangible fundamental reasons.
🔒 Subscriber-only content. Activate 14-day free trial or Login here
