Bond Market Sounds Small Cap Alarm  | | Robert Ross
Speculative Assets Specialist
Manward Press | We're partying like it's 2011. Moody's, one of the three major credit ratings agencies, downgraded the U.S. credit outlook from "stable" to "negative" after the market closed on Friday. It wasn't a full downgrade like we saw from Fitch in 2023 or S&P back in 2011... But it was a warning shot. And sure enough, it made headlines. I got a few texts from friends and family asking the same thing... What does this downgrade mean for stocks? They're all asking the wrong question. Because while everyone's focused on Moody's, the real story is what's happening in the bond market, particularly long-term Treasury yields. The 30-year Treasury yield quietly broke above 5% this week. That's not a headline grabber like a Moody's downgrade, but it's a much bigger deal for investors, especially if you're in small caps. Yields vs. Ratings When a company or country gets downgraded, it's usually just a reflection of risks that are already priced into the market. Moody's didn't tell us anything we didn't already know. U.S. debt is rising. Interest costs are ballooning. And the political will to fix either problem? Pretty much nonexistent. But bond yields? They're real-time signals. The 30-year Treasury yield crossing 5% means the market is demanding higher compensation to lend money to the U.S. for the long haul. That's a big deal. Nearly everything in our financial system is priced off Treasury yields. Mortgages... auto loans... credit card APRs... business financing. When Treasury yields rise, borrowing costs for everyone else go up, too. And this doesn't just impact consumers. It hits businesses hard, especially small and mid-sized companies that rely more on debt to grow. Small Caps Have a Duration Problem Think of it this way. If you're running a local manufacturer, software startup, or specialty retailer, odds are you're not sitting on $100 billion in cash like Apple. You need to borrow to expand, hire, and invest in new products. When the 10-year or 30-year yield rises, borrowing costs go up. That's what we're seeing now. It's part of the reason why small caps have struggled relative to the mega caps, despite attractive valuations and improving fundamentals. The iShares Russell 2000 ETF (IWM) is still lagging the broader market. In fact, small cap stocks have seen their biggest outflow ever this year due to sky-high rates. And until long-term rates stabilize, or fall, I expect this to continue. 
View larger image Remember, most small caps are "rate sensitive." They're the first to feel the squeeze when money gets more expensive and the last to benefit when liquidity returns. That's why I've been selective, even though I've been pounding the table on small cap opportunities all year. That includes ThredUp (TDUP), which we just sold for a 100% gain yesterday in the Breakout Fortunes portfolio. Not bad considering we opened this position on April 17... 
View larger image While there are headwinds for small caps right now, there are also plenty of opportunities. You simply need to know where to pick your spots. A Deteriorating Backdrop for Growth The rising cost of capital isn't just a theoretical concern... it's already impacting the real economy. Recent data shows that the demand for loans from businesses is falling. Delinquencies on credit cards and auto loans are rising. And mortgage activity? Still near cycle lows. These are the kind of second-order effects that higher yields bring. And if yields stay elevated, or worse, go higher, this could trigger a credit crunch across the economy. That's the real risk, not Moody's changing a label on a spreadsheet. The silver lining? If the economic data worsens, the Fed will be forced to step in. And Treasury Secretary Scott Bessent has already signaled that stabilizing bond markets is a top priority. But until then, elevated yields are like gravity... they pull valuations lower and slow everything down. Right now, the 10-year yield is hovering near 4.6%. The 30-year just touched 5%. If we see these yields continue to grind higher, expect more pressure on small caps and growth stocks in particular. But if they stabilize - or roll over - that's the green light to get more aggressive. Ignore the Moody's noise. Watch the bond market. Stay safe out there, Robert Want more content like this? | | | | | | 
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