Latest / Stock Picking with Fexingo: Individual Equities, Research, and Building a Concentrated Portfolio / Why Small Caps Are Finally Outperforming Large Caps in 2026
Transcript
- Lucas: You know that feeling when a shift has been whispered about for months and it finally shows up in the numbers? Well, this week it happened. Small caps are decisively outperforming large caps, and I think it marks a real turning point. Luna: I've seen the Russell 2000 up 1.2% in the last five days while the S&P is up 0.9%. That gap might not sound huge, but it's actually the widest we've seen since early 2025. Lucas: Exactly. And the Russell sits at 2,980 right now, within striking distance of 3,000. Meanwhile, the S&P is at 7,501 — a round number that feels heavy. The big question is whether this is just a catch-up trade or the start of a multi-year regime where small caps lead. Luna: I lean toward the latter. Let's talk about why. Lucas: There are three concrete catalysts. First, the rate-cut narrative is getting more credible. The Fed under Kevin Warsh is signaling a more measured approach, and markets are pricing in a cut before year-end. Small caps are more sensitive to borrowing costs — they carry more floating-rate debt than mega caps. So lower rates directly boost their earnings power. Luna: Second is the dollar. It's been weakening on the back of that Fed dovishness and the Iran peace talks. A weaker dollar helps companies with mostly domestic revenue — which is basically the entire Russell 2000. Lucas: Right. The average small-cap company generates about 80% of its revenue inside the U.S. Compare that to the S&P 500, where over 40% of revenue comes from abroad. So when the dollar falls, small caps don't get the translation hit that multinationals do. Luna: And the third catalyst? Lucas: Valuation. Small caps have been cheap relative to large caps for years. The price to earnings ratio on the Russell 2000 is about 16 times forward earnings, versus 22 for the S&P 500. That discount is near historic extremes. At some point, the market rebalances. Luna: It's interesting because a lot of the flows we're seeing support this. IWD — the iShares Russell 1000 Value ETF — is up 0.3% in five days, but VTV, the Vanguard Value ETF, is actually down 0.3%. So within value, the large-cap part is lagging. Lucas: That's a great point. The rotation isn't just about size — it's about where the value is. And the real value is in smaller companies that have been ignored. Look at regional banks. They've been beaten down since the 2023 banking turmoil, but now with a flatter yield curve and rate cuts ahead, their net interest margins could stabilize. A regional bank like KeyCorp or Regions Financial — both in the Russell — have started to perk up. Luna: And industrial REITs are another pocket. These are companies that own warehouses and distribution centers. They benefit from domestic supply chain reshoring, and they're mostly small- or mid-cap. Lucas: Yeah, take Rexford Industrial — it's a pure-play industrial REIT in Southern California, market cap around $11 billion. Its stock is up about 8% in the last month. That's the kind of move that tells you money is rotating into smaller names with tangible assets. Luna: Meanwhile, the mega caps are having a more mixed week. Apple up 2.4%, Microsoft down 2.9%, NVIDIA up 2.7%. It's not a uniform sell-off, but the energy sector is getting crushed — ExxonMobil down over 6% in five days, Chevron down over 7%. That's dragging on the large-cap indexes. Lucas: Energy is a separate story — oil prices falling on demand concerns and the Iran talks — but it's part of why large caps as a whole are struggling. The S&P 500 is top-heavy with energy and tech. When energy tanks and tech is mixed, the index doesn't get much lift. The Russell, by contrast, has almost no energy exposure. It's all domestic cyclical and financials. Luna: So for an active stock picker, the opportunity is in finding those small caps that are fundamentally sound but have been overlooked. But you have to be careful — liquidity is thinner, and volatility is higher. Lucas: Absolutely. You can't just buy the index and walk away. You need to do the work. Which brings me to something we believe strongly in on this show. We deliberately keep it ad-free because we want the conversation to be about ideas, not products. If you find that valuable and want to support it, you can find us at buy me a coffee dot com slash fexingo. That's it — no pressure, just a way to keep this independent. Luna: Yeah, and we mean that. The whole point is that good research should speak for itself. So back to small caps — what are you watching specifically? Lucas: I'm focused on companies with low debt and high insider ownership. One name I've been digging into is Simpson Manufacturing — a $9 billion market cap company that makes wood construction products. It's got a strong balance sheet, consistent free cash flow, and it's trading at 18 times earnings. That's a small-cap value stock that could compound nicely. Luna: And the housing market is stabilizing — that helps. Lucas: Exactly. Another is Fabrinet — a precision optical components manufacturer. It's in the Russell 2000, market cap about $8 billion. It benefits from data center buildout and has a 15% compound annual growth rate in earnings over the last five years. That's not a speculative story — that's a real business. Luna: What about the risk of recession? If the economy slows, small caps usually get hit harder than large caps because they have less pricing power. Lucas: That's a valid concern. But the data right now doesn't point to a near-term recession. Jobless claims are low, consumer spending is still positive, and the manufacturing PMI has been creeping above 50. The soft landing narrative is still intact. If that changes, then small caps would definitely underperform. But for now, the macro is supportive. Luna: So the play is: buy small caps with strong fundamentals, low leverage, and domestic revenue. That's the formula. Lucas: And be prepared to hold for 12 to 18 months. This rotation could take time to play out. But the setup is the best I've seen in years for active stock pickers who focus on smaller companies. Luna: Alright, let's keep tracking it. Next week, maybe we can look at specific sectors within small caps that are leading. Lucas: Good idea. I'll come with some data on the top 10 industries in the Russell that have gained the most over the last month. Luna: Looking forward to it.