Wall Street's Wednesday: Tariffs, Small Caps, and Bitcoin's Surge

Wednesday was a day of high drama on Wall Street, as investors braced for President Donald Trump’s tariff announcement and navigated a market landscape marked by volatility and unexpected rallies. The S&P 500 and Nasdaq 100 both saw early losses, but the Russell 2000 Index of small-cap stocks staged a remarkable comeback, rising 9% for the month of July. Meanwhile, Bitcoin surged past $87,000, igniting a wave of short liquidations and signaling a potential shift in market sentiment.



The rally in small-cap stocks has been driven primarily by multiple expansion rather than actual earnings growth. This trend is notable because it contrasts with historical market trends where small-cap stocks typically underperform large-cap stocks over extended periods. For instance, the Russell 2000 Index of small-cap stocks had underperformed the large-cap S&P 500 Index by 103% in the past decade, ranking as the fourth-worst stretch for small caps in comparison to large caps in a century. This underperformance was so severe that as of mid-2024, the Russell 2000 stood barely positive on the year, while the S&P 500 had posted a 15% gain, largely due to the performance of the "Magnificent Seven" tech stocks.

The implications for long-term investors are significant. The rally in small caps, driven by multiple expansion, raises questions about its sustainability. Multiple expansion occurs when the price-to-earnings ratio of stocks increases, often due to investor sentiment and market conditions rather than fundamental improvements in the companies' earnings. This type of rally can be volatile and may not be supported by underlying economic fundamentals. As a result, long-term investors need to be cautious. The rally could be a blip or the beginning of a new trend in market leadership, but without clear evidence of earnings growth, the sustainability of this rally is uncertain. Investors should consider actively managed small-cap allocations to navigate this volatility and potentially benefit from the rally while being prepared for potential corrections.

The upcoming tariff announcement added another layer of uncertainty to the market. President Trump’s “reciprocal” tariffs, set to be unveiled on what he has dubbed “Liberation Day,” aim to revive U.S. manufacturing while penalizing countries he accuses of engaging in unfair trade practices. However, most economists believe these tariffs could push the economy into a recession and strain longstanding alliances. The derivatives market is already pricing in more volatility ahead, with options traders betting that the S&P 500 will move roughly 1.1% in either direction on Thursday following the tariff announcement.

Tesla, one of Wall Street’s most influential stocks because of its immense size, has faced growing backlash due to anger about CEO Elon Musk’s leading the U.S. government’s efforts to cut spending. Tesla helped pull the market lower after it said it delivered fewer electric vehicles in the first three months of the year than it did in last year’s first quarter. Its shares fell 2.2% to extend their loss for the year so far to 35%. Tesla, one of Wall Street’s most influential stocks because of its immense size, has faced growing backlash due to anger about CEO Elon Musk’s leading the U.S. government’s efforts to cut spending.

The rally in small-cap stocks and the surge in Bitcoin highlight the market’s resilience in the face of uncertainty. Small-cap stocks, which have historically been more volatile, have shown remarkable strength in recent weeks. The Russell 2000 Index hit its first record high since November 2021 this week and just saw its best monthly performance since last December. The index is up almost 11% in November and 35% over the past 52 weeks as of Friday's close. This rally has been driven by multiple expansion rather than actual earnings growth, raising questions about its sustainability. However, the rally has been a de-risking event, with investors reducing some exposure to large-cap positions and rotating into small-cap names.

Bitcoin’s surge past $87,000 is a significant milestone, signaling its resilience in the face of volatile markets. Institutional adoption remains a major driver, with companies like BlackRock and Fidelity Investments showing interest in Bitcoin ETFs. These ETFs make it easier for traditional investors to access Bitcoin, broadening its appeal. Bitcoin’s integration into mainstream financial systems, coupled with increasing corporate treasuries holding Bitcoin, underscores its acceptance as a viable asset class. In addition, macroeconomic factors like inflation concerns have spurred demand for Bitcoin as a hedge against currency devaluation. The cryptocurrency’s finite supply, capped at 21 million coins, contributes to its scarcity and value.

In conclusion, Wednesday’s market movements highlight the complex interplay of factors driving investor sentiment. The rally in small-cap stocks, the upcoming tariff announcement, and the surge in Bitcoin all point to a market that is both volatile and resilient. Investors should adopt a balanced approach that combines diversification, sector rotation, hedging strategies, and a focus on long-term fundamentals. By doing so, they can navigate the current market volatility and the upcoming tariff announcements while positioning their portfolios for long-term growth.