(New York)

Small caps are having a great year so far, but there are increasing worries that the good times might not last. The Russell 2000 is outperforming the S&P 500 by 3% (13% vs 10%) this year, but has tumbled in recent days, a troubling sign. What could be driving the losses is that the big gains in price have not corresponding to improving fundamentals. For instance, small cap performance is very tied to purchasing managers index data (PMI), but the rise in price has not been tied to changes in the PMI. Additionally, small cap companies tend to have the most floating rate debt, which puts them at a higher risk of rising rates. They also tend to have much lower credit quality, meaning they are the most susceptible to shifting rates. More than half the debt issued by small companies is rated as junk.

FINSUM: There is no reason to think the bottom is going to fall out here. However, a sense check seems necessary for small cap investors as there are significant risks.