When the market rose, large-cap stocks won. They are winning again on the downturn.

This is not how it should be. Wall Street has seen the market expand beyond the “Magnificent Seven” Big Tech stocks in recent weeks, helped by the dismal performance this year of once-great Tesla (down 41%) and Apple (down 14%). We have been promoting the idea that

It may be broader than the seven stocks, but April continued to be strong for the larger stocks, with the exception of Friday, when some of the major stocks fell sharply. Dividing the S&P 500 into 10 groups shows a near-perfect decline in performance by size. The largest 50 companies are down just 4.5%, and the smallest 50 are down 8.6%. This pattern is more regular than it was in the first three months of the year, when large-cap stocks were noticeably bigger.

This is not just an S&P problem. After all, the S&P is made up of the 500 or so largest stocks. The Russell 2000 index of small and medium-sized companies lagged far behind in gains, increasing less than 5% in the first quarter versus his 10% for the S&P. The Russell 2000 then fell further during the month’s decline, dropping 8.3% versus the S&P’s 5.5% decline. The Russell Microcap Index, which includes the smallest companies, rose even more narrowly and fell even wider.

The main reasons are interest rates and, more recently, concerns about broader Middle East wars. Both are hurting small businesses far more than large corporations, and higher interest rates are even boosting profits for some large companies.

The impact of rising interest rates is part of a two-speed economy, with rapid interest rate increases followed by evaporation of expectations for multiple rate cuts. Large companies have been shielded from the effects of rising interest rates because they have taken advantage of easy access to bond markets when interest rates were low to lock in ultra-low-cost debt for long periods of time. Many mega-capitalization stocks, especially big tech stocks, are also sitting on huge amounts of cash, and their profits are rising thanks to rising interest rates.

In contrast, smaller companies have difficulty issuing corporate bonds and borrowing much more at variable interest rates. Like poor consumers who take out credit card debt, the cost of this debt has soared as the Fed tightens, hurting profits for small businesses. Analysts at Goldman Sachs calculate that nearly one-third of Russell 2000 bonds have variable interest rates, compared to 6% of S&P 500 bonds.

In addition, small and medium-sized enterprises as a group have more debt than revenue and earnings are more volatile, making them less attractive when a flight to quality occurs under the threat of war.

All of this manifests itself in the Russell 2000 moving significantly in the opposite direction of bond yields. Meanwhile, there has been no correlation between this year’s movements in bond yields and the top 50 stocks, leading to an unusual split between the two indexes.

Surprisingly, the excitement around artificial intelligence is not a good explanation for why the biggest stocks win. Indeed, giant chipmaker Nvidia soared 91% this year to its all-time high on March 25th, but has fallen 15% since then, including a 10% plunge on Friday, far worse than the Russell 2000. Stocks should have fallen this month after large-cap stocks performed well in the first quarter, but they still outperformed small-cap stocks. Additionally, AI cannot explain why there is such a clear pattern of performance across scale. This is not just a problem for a handful of big AI winners.

This pattern is surprising to those who remember 2022, and suggests that investors are now more focused on profits. In 2022, Big Tech and other growth stocks were crushed by plummeting valuations, even if profits were good. The argument was that growth stocks’ profits are further into the future than cheap value stocks, so a rise in long-term bond yields should make future profits less valuable. The bird in hand is worth more if it makes a safe return of 4% or more than if it earns 0%. Therefore, the charm of his two birds in the bush fades.

The difference this time is that interest rates were higher from the beginning. 10-year U.S. Treasuries fell nearly 20% in value in 2022 as yields rose, but have fallen just 6% this year. At the time, investors paid little attention to size and were selling growth potential rather than value (both S&P’s largest and smallest member countries performed poorly). This year, investors bought growth over value, but size mattered more.

Meaningful. Not only are changes in interest rates less impactful when interest rates are already high than when they are very low, but investors are also wise to recognize the disparate impact of rising interest rates on their returns. While valuations are still very high, they are lower than they were at the end of 2021. That doesn’t make large-cap wins any easier for investors who continue to hope that small-cap stocks will one day prove their worth.

Email James Mackintosh at james.mackintosh@wsj.com.