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Why are small cap stocks so weak?

The S&P 600 Small Cap Index has fallen 25% since late November, which is below the 20% decline that Wall Street defines as a “bear market”. As the monthly price chart below shows, small cap stocks have broken below their key long-term 36-month moving average and the trend line that has supported prices since the covid panic low of 2020. To add further to the bearish picture, they have been underperforming the S&P 500 since mid-2018 (second clip) and long-term momentum is negative based on the monthly PPO (third clip). This suggests the recent decline is not a normal pullback and there is more downside to come.

small cap

Why?

By definition, small businesses are riskier than large businesses and have greater difficulty accessing credit when they need it. This makes them particularly vulnerable in a recession.

Trump Turns From Savior To Villain For Small Businesses

While Wall Street tends to ignore small businesses because they get paid more by bigger companies. But small businesses generate about 45% of US GDP and hire about 45% of US workers. That is why we do not ignore them.

The monthly NFIB small business survey provides detailed insights on the state of small businesses that are available nowhere else. Since it is information not provided by the government, Wall Street ignores this information, as well.

Their latest survey is worrisome, as we detail here.

As this chart shows, the NFIB Small Business Optimism Index fell by 3.3 points to 97.4 last month, below the 51-year average of 98. This was the largest decline since June 2022, when everyone thought the US was in a recession.

Optimism

The net percentage of small businesses anticipating better business conditions fell by 16 points to 21%. This is the third straight decline and the largest since December 2020, in the midst of the covid lockdowns.

Real sales expectations are at recessionary levels, as shown below. The net percent expecting higher real sales fell 11 points to 3%, which is the third consecutive monthly decline.

Sales

Earnings are also at recessionary levels. The percentage reporting positive profit trends fell 4 points to a net negative 28%, as this chart shows.

earnings

Given this weak environment, it is no surprise that small businesses are not eager to hire workers. Only a net 12 percent of owners plan to hire in the next three months, down 3 points from February. These are the weakest hiring plans in nearly a year.

employment

The small business Uncertainty Index remains near record highs. Trump’s chaotic trade war is certainly not helping.

uncertainty

The NFIB summarized the results of their survey as follows:

“This year will be one ruled by uncertainty. Global and domestic actions are generating insecurities in abundance, both political and economic. President Trump’s administration is rearranging the deck chairs at a record pace. Is there an “iceberg” looming ahead or will we sail through to a restructured economy safely? Since 1986, NFIB’s Uncertainty Index (based on the percent of respondents reporting “uncertain” or “don’t know” to six questions) has averaged 68. But, since 2016 it has averaged 80 and reached its highest level of 110 in October 2024.

NFIB’s Small Business Optimism Index declined in March to 97.4, just below the 51-year average of 98, three months after reaching a near record high of 105.1 in December. Since last October, the Index component “Expected Business Conditions” has moved from net negative 5 percent to net 52 percent in December, and now back down to net 21 percent, “expectational whiplash!”

Inflation remains a sticky problem. The Consumer Price Index rose to 9.1 percent in June 2022, and has fallen to below 3 percent but not yet reaching the Fed target of 2 percent. From 2020 to 2024, the level of prices (CPI) increased 20 percent (cumulative). This delivered a huge reduction in purchasing power to consumers who now wish to see prices fall, not just rise more slowly. The net percent of owners raising selling prices was 26 percent in March, much lower than the 66 percent level reached in March 2022, but still historically high. From 1986 to 2020, the average was 8 percent! It is no surprise that historically high numbers of small business owners have recently picked inflation as their most important problem.”

Investment Implications

What happened to Jay “Transitory Inflation” Powell’s “softish landing?” What happened to Trump’s “pro-business” policies? If you ask small businesses, they will tell you that DC’s monetary, fiscal and global trade war policies are killing the entrepreneurial spirit in America.

That is why small cap stocks — and mid and large cap stocks, to a lesser extent — are so weak. Unfortunately, it doesn’t look like that is going to get better any time soon.

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