A rally in the Russell 2000 that began after April's Liberation Day tariff shock has pushed stocks of unprofitable companies up about 60% since then, far outpacing the 38% gain for profitable small-cap firms. Apollo Global Management's chief economist Torsten Slok warns that the market has stopped pricing risk the way it once did, as loss-making companies keep outperforming.
The divergence widens
Of the roughly 2,000 members in the Russell 2000, 806 carried negative trailing earnings while 1,120 were profitable. The gap between the two groups has only grown since the April low, when the index surged nearly 44%. Micro-cap stocks have done even better, rising about 66% off that bottom, led by semiconductor makers.
Most of the loss-making companies are in tech sectors — software, semiconductors, biotech — all riding the artificial intelligence wave. That's helped fuel the rally, but it's also raising eyebrows.
Something is broken, says Slok
Slok, who first flagged the vulnerability of loss-making firms to high rates and slowing growth back in November 2023, wrote bluntly: 'Something is broken in price discovery when companies with negative earnings keep outperforming companies with positive earnings.' He didn't mince words about what he sees as a disconnect between risk and reward.
The divergence had widened through mid-2026, according to the data, suggesting the trend has persisted well beyond the initial shock.
Cost of capital vs. return on assets
Morgan Stanley's Lisa Shalett pointed to a structural problem: small-cap firms carry a cost of capital above their return on assets. That math makes it hard for many to generate value, especially if borrowing stays expensive or growth slows.
But not everyone is sounding the alarm. Royce Investment Partners' Francis Gannon argues that many of these small caps are genuine suppliers to the AI buildout, not just speculative bets. He expects stronger small-cap earnings growth in 2026 as those investments start paying off.
The question now is whether the market's risk appetite will eventually correct, or whether the AI wave can keep lifting even the unprofitable boats. The next earnings season will offer one clue, as investors watch to see if revenue growth at loss-making tech firms can turn into actual profit.
