How much is the Russell 2000 Index exposed to the risk of impact from Iran?

Investing.com — The escalation of tensions in Iran has reignited concerns about how U.S. small-cap stocks might react, with U.S. banks warning that the key risk lies in a stagflation shock driven by oil.

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Analyst Jill Carey Hall wrote that U.S. bank macro teams expect that, assuming the conflict doesn’t last too long, the impact on oil prices will be “limited (an increase of $10-15 per barrel),” but warned that “if the Strait of Hormuz remains closed for an extended period, Brent crude could rise by $40-80.”

U.S. banks pointed out that the Russell 2000 index tends to fall more sharply than large-cap stocks during risk-averse periods, typically dropping “8-11%, underperforming large caps by about 1-2 percentage points.”

However, the index usually rebounds quickly, with Hall noting that small caps “not only fully recover within three months but also increase by 11-12%, outperforming large caps by about 1 percentage point.”

The bank’s research emphasizes that small-cap stocks tend to perform better than large caps in a stagflation environment.

Hall wrote that small caps currently “have more exposure to industries benefiting from rising oil prices and less exposure to industries harmed by higher oil prices,” adding that during past stagflation periods, small-cap value stocks “delivered particularly strong returns.”

However, U.S. banks also pointed out that this sector is now much more sensitive to Federal Reserve policies, which is an important warning sign.

Small caps “have high leverage and increased refinancing risks,” meaning that if the expectation of rate cuts diminishes and markets start pricing in rate hikes, the Russell 2000 could face challenges.

According to U.S. banks, in the current environment, “small caps with oil exposure but limited refinancing risk may be in the most favorable position.”

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