Attention from Zhitong Finance APP: The Russell 2000 index entered correction territory following Wednesday's sharp selloff, as rising inflation and interest rates are pushing the market's riskiest stocks below key moving averages.

This small-cap benchmark has now fallen more than 10% from its most recent peak, recording its first technical correction since March after dropping 1.9% on Wednesday. Wednesday's decline was broad-based, with the number of declining stocks in the index roughly five times the number of advancing ones. Overall, the benchmark is down 11% from its August high.

The inflation report released Wednesday showed that prices in September rose at the fastest pace since April, with core inflation coming in above expectations. Stefano Pascale, head of U.S. equity derivatives research at Barclays, said, "Small caps are highly sensitive to interest rates, and to the extent that today's data increases the risk of higher policy rates, that's a bad sign for small caps."

Small-cap index down 11% from its peak

For most of this year, the Russell 2000 outperformed the S&P 500, as small caps are closely tied to economic growth, which has been driven by strong consumer spending and massive corporate investment in artificial intelligence (AI) infrastructure. However, after the Federal Reserve raised rates and bond and Treasury yields surged, the index surrendered its lead last month.

Small caps tend to be more sensitive to interest rates than large caps. In fact, as rates climbed, the index has broken through multiple support levels, falling below its 200-day moving average this week for the first time since March. Previously, in September and August, it had already dropped below its 100-day and 50-day moving averages. Since forming a bearish V-shaped reversal pattern in August, the index has been in a downtrend. This week, it fell below the 23.6% Fibonacci retracement level — around 2,754 points — which had previously served as support.

Dennis DeBusschere, president and chief market strategist at 22V Research LLC, said Wednesday's CPI increase raises the risk of further tightening in financial conditions, which will "pose a persistent longer-term headwind for small caps," as well as for consumer and transportation stocks.

Earlier this year, after a large-scale index rebalancing, the high-quality constituents within the small-cap benchmark also pulled back sharply. As of June 29, Bloom Energy Corp. (BE.US), Credo Technology Group Holding (CRDO.US), Sterling Infrastructure Inc. (STRL.US), and TTM Technologies Inc. (TTMI.US) together accounted for two-thirds of the Russell 2000's gains, and on that very day, all four companies were moved into the Russell 1000 index.