After a strong rally in smaller company shares, hedge funds are intensifying their short-selling activity, signaling growing uncertainty about the U.S. economy’s ability to withstand ongoing global trade tensions.
Data from Goldman Sachs’ trading desk reveals that in July, short interest on the Russell 2000 Index climbed to $16 billion—levels not seen since 2021. At the same time, net futures exposure on the Russell 2000 is approaching its lowest point in a year, diverging sharply from the upbeat investor sentiment in Nasdaq 100 futures, which remain close to all-time highs. Goldman Sachs describes this gap between small-cap and tech-focused futures as unprecedented.
Typically, small-cap companies have weaker balance sheets and less access to credit than larger S&P 500 firms, making them more vulnerable to economic shifts. Although small caps have outperformed large caps since their April lows, doubts linger about whether U.S. growth can maintain momentum amid President Donald Trump’s efforts to renegotiate trade deals.
Small caps have trailed behind big tech giants, especially during the AI boom that propelled stocks like Nvidia (NASDAQ: NVDA). Last year, smaller companies initially gained from the so-called “Trump trade,” as investors anticipated that trade restrictions would spur domestic demand. However, concerns over slowing growth and persistently elevated interest rates—impacting smaller firms more due to their dependency on external funding—have cooled enthusiasm.
Since April, the Russell 2000 has surged 26%, prompting some analysts to warn that such rapid gains could indicate an overheating in risk appetite.
Sentiment toward small caps might improve if the U.S. economy shows continued strength or if moderate inflation bolsters expectations for Federal Reserve rate cuts. Market participants are currently pricing in the possibility of interest rate reductions as early as September, though October appears to be a more probable timeframe.
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