Goldman Sachs Warns That The Blistering Rally In Small-cap Stocks Will Fade Soon

• The small-cap Russell 2000 has surged amid a market rotation that's taken place in recent months.
• Yet, Goldman Sachs says the momentum is destined to fade.
• Waning fuel from the AI trade and a more hawkish fed will hobble further strong gains.

The small-cap Russell 2000 has had a big run this year, outpacing the tech-laden Nasdaq 100 to post a year to date gain of about 20%. But don't get used it, Goldman Sachs says.

According to the bank, the small-cap rally can be largely attributed to AI, with the infrastructure boom trickling down from the tech sector's leaders. But even as small-caps have outperformed, there are budding risks to smaller companies that mean the rally is likely going to fade.

"The combination of elevated valuations and near-trend US economic growth points to low single-digit Russell 2000 returns in the next 12 months," wrote Goldman analyst Ben Snider in a note to investors.

Finance pros began noticing the strength of small-cap stocks in Summer 2025, highlighting the group as an overlooked winner of the broader AI trade. Now Snider's team sees the market shifting in a different direction for two reasons.

First, the Russell 2000 recently went through its June 2026 reconstitution, which slashed the weight of the index's AI infrastructure stocks in half, reducing it from 15% to 7%. That number matters because a large portion of companies in the index are not actually profitable.

"While analyst estimates point to strong EPS growth, roughly a quarter of the Russell 2000 is unprofitable," Snider added. "Unprofitable stocks represent 29% of Russell 2000 constituents and 23% of market cap. This unprofitable share has trended higher during the past 20 years and increased slightly following last week's rebalance."

Second, monetary policy risks are rising for small-cap stocks as Kevin Warsh begins his tenure as chair of the central bank. The Russell 2000 is full of companies with floating rate debt, who could suddenly end up owing a lot more if the Fed decides to hike interest rates.

Even after Thursday's tepid jobs report, markets still think the Fed could raise rates at least once this year, which would have an outsize negative impact on the more rate-sensitive small-cap sector.

"A Fed tightening cycle would pose a bigger risk to small-caps than large-caps," Snider said. "While our economists believe that the Fed will most likely remain on hold for the next few quarters, the market is pricing roughly 35 bp of Fed tightening through year-end. About 30% of Russell 2000 debt is floating rate, compared with 7% for the S&P 500."