Small Cap Breakout: Why a ‘Great Releveraging’ Could Boost Investor Appetite for Risk Assets
Bank of America sees trillions in sidelined cash poised to flow into small caps and other risk assets as rates fall.
Small-cap stocks are showing new life, with the Russell 2000 Index (RUT) climbing to fresh all-time highs as investors start to price in a powerful shift in the financial landscape. Bank of America (NYSE: BAC) Securities calls it the “Great Releveraging,” a period when lower interest rates could unleash trillions of dollars in idle cash from savings accounts and home equity into riskier corners of the market.
The Russell 2000 closed Wednesday at a record 2,519.75, up 0.97% on the day and 33.82% over the past six months. Its exchange-traded counterpart, the Russell 2000 Index ETF (NYSE Arca: IWM), has jumped 12% in three months, outperforming the S&P 500 (SPX), which has gained 8.8% in the same period.
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BofA’s “Great Releveraging” Playbook
According to Bank of America Securities, falling interest rates could mark the start of a new risk cycle. The firm estimates that if 30-year mortgage rates drop to 5% and 10-Year Treasury Yields (USD10Y) fall to 3.25%, consumers may begin pulling cash from low-yield savings and home equity to reallocate toward higher-return assets like small caps, long-term bonds, and gold.
“These levels are not our baseline forecast, but they may not be out of reach,” the bank wrote.
Lower borrowing costs would boost spending, improve liquidity, and stimulate risk-taking, precisely the conditions small-cap companies thrive in. These firms, often more leveraged than their large-cap peers, are highly sensitive to borrowing costs. As rates decline, their balance sheets improve, and investor confidence tends to follow.
Small Caps Outperform as Technicals Confirm Breakout
The Russell 2000 has been stuck in a multi-year rut since late 2021, but recent technical action suggests that era of stagnation may be over. Analysts note that IWM is breaking out from a four-year base structure, with long-term Fibonacci projections pointing to potential targets around $300, roughly 19% above current levels.
An old Wall Street adage, “the longer the base, the higher in space”, appears to be playing out. Like gold’s decade-long consolidation before its breakout earlier this year, small caps may finally be primed for sustained outperformance.
Katie Stockton, founder of Fairlead Strategies, sees strong confirmation of the trend, telling CNBC:
“This should be important to investors who are heavily exposed to large-cap technology, and might warrant a shift in portfolio allocations to manage risk and leverage a possible breakout in the Russell 2000 Index, which would occur on two consecutive weekly closes above ~2460 (Nov 2021 high) in a bullish long-term development.”
Her call came just before the index notched a new intraday record of 2,541.67, marking its fifth record high of 2025.
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Fed Shift Fuels Risk Appetite
The Federal Reserve’s recent pivot into rate-cutting mode has been the key catalyst. Yields on 10-year Treasuries have fallen to around 4.1%, with market expectations now pointing to a drop to 3.25% within a year. Futures data show investors increasingly betting on the federal funds rate declining to 3.25% or lower, levels that could supercharge risk appetite.
Dryden Pence, chief investment officer at Pence Wealth Management, told Barron’s that he expects falling rates and improving earnings to lift both large and small caps next year. “If earnings are going to go up 10%, the market’s probably going to go up 10%,” he said.
Pence, who highlighted small- and mid-cap firms as major beneficiaries of easing conditions, noted:
“[Going into 2026] I think we’ll begin to see the broadening out of the S&P 500 and the maturation of this earnings growth, but I think the real opportunity here is coming up in small- and mid-caps. Half of the Russell 2000 doesn’t make money. But the other half of the Russell does. The half of the Russell that makes money, those guys are probably going to see margin expansion. They’re going to see lower interest rates. They’re going to see increased demand. They’re going to see better efficiencies.”
A Broader Reallocation Cycle
The rotation into smaller equities is occurring alongside gains in Gold (XAUUSD) and the SPDR Gold Shares ETF (NYSE Arca: GLD), both of which have climbed as investors seek inflation hedges amid looser monetary policy. The Nasdaq 100 Index (NDX) and Nasdaq 100 Index ETF (NASDAQ: QQQ), which dominated market performance for much of the post-pandemic era, are now showing signs of fatigue relative to IWM, another technical signal favoring a broader market shift.
Even within the small-cap universe, leadership is emerging. Top IWM components such as IonQ (NYSE: IONQ), Oklo (NYSE: OKLO), and Credo Technology (NASDAQ: CRDO) have posted strong gains, reflecting investor enthusiasm for quantum computing, next-generation energy, and semiconductor connectivity, three themes central to the U.S. innovation economy.
Outlook: From Liquidity Trap to Expansion Cycle
With trillions of dollars still sitting in high-yield savings accounts and home equity, the potential for capital rotation remains immense. Bank of America points out that household cash levels are at their highest since 1991, a result of tight monetary policy that kept many Americans on the sidelines. Now, with rates easing, that wealth may begin to circulate again.
If history is any guide, small caps and other rate-sensitive assets could see the strongest upside. During past easing cycles, home builders outperformed by 20 percentage points on average, while small caps often led the broader market in the first year of monetary loosening.
Steven DeSanctis, small- and mid-cap strategist at Jefferies, expects that trend to continue, stating:
“We don’t see a lot of upside in large cap. We see more upside-down market cap [as attractive].”
As the “Great Releveraging” narrative gains momentum, investors appear to be voting with their wallets. After years of underperformance, small caps have re-emerged as one of the market’s most compelling comeback stories, and perhaps the clearest beneficiary of America’s next liquidity-driven expansion.
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