These bellwether stocks have flashed a larger market signal of underlying economic strength
Recent gains by small-cap stocks are a sign of a broader rally, LPL Financial's Quincy Krosby wrote.
It also points to a sturdier economy as the Russell 2000 index is seen as riskier than the S&P 500.
"Steady interest in small-caps suggests the economy is more resilient than the headlines imply."
Recent momentum in small-cap stocks may indicate a broader market rally and a stronger economy, according to LPL Financial Chief Global Strategist Quincy Krosby.
Citing gains in the Russell 2000 index, the analyst pointed to signs of improving market breadth, followed by indications of more participation from institutional investors.
The Russell 2000 surged nearly 10% from a May low, led by banks and industrial stocks. In the months before that, rises in the Russell were temporary, Krosby told Insider, climbing on headlines like news of a bank sale.
That's as small-caps had been passed over earlier this year in the wake of regional bank failures in March, prompting a loss of confidence in the lending sector.
"Given that the Russell 2000 is heavily populated by banks, seeing the index gain support suggests we're finally moving beyond the worry that another bank-related headline is going to throw financial markets into a tailspin," she wrote in a note Wednesday.
"Moreover, small-caps have traditionally served as a bellwether in terms of the broader economic landscape. With all the ongoing debate regarding the state of the economy, and concerns about an impending recession, steady interest in small-caps suggests the economy is more resilient than the headlines imply, or that a recession could be milder than initially projected."
To be sure, the S&P 500 has also shown signs of increased participation, with more inflows to large-cap consumer discretionary shares, adding to the notion of broadening market support, Krosby added.
And now, a new bull market has arrived on Wall Street after the S&P 500 rallied 20% from its October low.
Prior to that, the S&P 500 relied heavily on a handful of mega-cap stocks as investors piled money into technology stocks linked with artificial intelligence.
"Their rock-solid balance sheets and a record of strong earnings have become a primary reason for their outsized performance during periods of uncertainty, in defiance of a legion of experienced money managers and analysts," Krosby wrote. "To be sure, the 'AI' factor only added to their allure."
Market veteran Ed Yardeni has warned that the mega-cap stocks may see the "mother of all melt-ups" followed by a major downturn.
Meanwhile, the Russell 2000 has entered overbought territory as it dipped on Friday, Krosby told Insider, with further weakening possible if the Federal Reserve hikes interest rates in its upcoming meeting.
"But the moves that we saw were significant," she added. "They weren't a one-off."
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