Latest / The Bear Market Podcast with Fexingo: Surviving Downturns, Buying the Dip, and Long-Term Resilience / How the Russell 2000 Is Defying the Nasdaq Selloff
Transcript
- Lucas: So the Nasdaq has been getting hammered — down about 4 percent in a week, while the Dow is roughly flat and the Russell 2000 is actually up a little. That kind of divergence tells you something real is shifting under the surface. Luna: It's the opposite of what we saw for most of last year, when mega-cap tech was dragging everything else along. Now the big names are stumbling and the smaller companies are holding up. Lucas: Exactly. And I think the key question is whether this is a genuine rotation — money leaving overpriced tech and going into areas that have been ignored — or just a temporary flight to safety before another leg down. Luna: What's driving the small-cap resilience right now? Because on the surface, small caps are usually more sensitive to economic slowdowns. Lucas: Right, they tend to be more cyclical, more debt-heavy, more exposed to domestic demand. But there are a couple of specific things working in their favor this time. First, the 10-year Treasury yield has been drifting lower — it's at 4.40 percent as of this week, down from over 4.6 percent in April. Lower rates are a bigger deal for small companies because they're more reliant on floating-rate debt. Luna: So the rate relief is disproportionately helpful for them. That makes sense. Lucas: Second, small caps have a much higher share of revenue coming from inside the US. If there's a trade war escalation or tariff uncertainty, they're less exposed than multinationals. And third, valuations have been compressed for years — the Russell 2000 price to earnings ratio is around 15, compared to the S&P 500 at over 22. Luna: So you're paying a lot less for companies that might actually benefit from a soft landing. But the VIX is at 18.41, up 9 percent in five days — that suggests people are nervous, not confident. Lucas: Yeah, the VIX spike is real. But I'd argue it's concentrated in tech stocks. The VIX is calculated from S&P 500 options, which are dominated by the mega-cap names. So when Apple and NVIDIA drop, the VIX jumps even if the rest of the market is calm. The VVIX — the volatility of the VIX — actually fell slightly, which suggests options traders aren't panicking about a systemic crash. Luna: So it's a tech-specific selloff, not a broad market freakout. That supports the rotation narrative. Lucas: Exactly. And I think the real driver is the shift in Fed expectations. Minneapolis Fed President Neel Kashkari said Friday he expects a rate hike this year. That's a hawkish outlier, but even the consensus has moved toward higher for longer. That hurts high-duration assets like growth stocks, where most of the value is in distant future earnings. Luna: Small caps are shorter duration. Their cash flows are more near-term. So if rates stay higher, they're less penalized. Lucas: Right. And if you look at the actual data, the Russell 2000 is up 0.1 percent over the past five days while the Nasdaq is down. The Dow is flat. The S&P 500 is somewhere in between. That's a textbook rotation out of growth and into value. Luna: I want to push back a little, though. Small caps have had these moments before — they rally for a few weeks, then fade. Remember the 'small cap renaissance' talk in late 2023? It petered out. Lucas: That's fair. But the difference this time might be the catalyst. In 2023, the rally was based on hope that the Fed would cut rates soon. That didn't happen. Now, we're actually seeing rate cuts priced in for late 2026, and the yield curve is steepening — the 10-year minus 2-year spread is 31 basis points, back to positive territory. That's historically a good sign for small caps, because it suggests banks can start lending more profitably. Luna: Banks are a huge part of the Russell 2000. So if the yield curve steepening continues, that's a direct tailwind. Lucas: Yeah, financials make up about 15 percent of the Russell, compared to maybe 6 percent of the S&P 500. So a steepening curve disproportionately helps the index. And we've seen regional bank stocks stabilize after the turmoil in 2023 and 2024. Luna: What about the risk of a recession? If the economy weakens, small caps get crushed first. Lucas: That's the bear case. Real GDP growth was 2.1 percent annualized in Q1, which is decent, but it's slowing from the 3 percent plus we had in 2024. The Atlanta Fed GDPNow tracker for Q2 is around 1.8 percent. So we're seeing a moderation, not a contraction. If that holds, small caps can tread water. If it tips into negative territory, then yeah, this rotation reverses. Luna: So you'd need a soft landing for the rotation to have legs. That's not a given. Lucas: It's not. But the market is starting to price in a higher probability of that scenario. And given how cheap small caps are relative to large caps — the spread is near historic extremes — I think it's worth paying attention to. You don't have to buy the whole index, but there are individual names that look interesting. Luna: Give me one example of a small cap that might benefit from this environment. Lucas: I'll pick one that's not a household name: a company called CBIZ, which provides financial services to small and mid-sized businesses. They've been growing earnings at about 10 percent a year, they have low debt, and they're heavily domestic. Their stock is down about 8 percent this year despite solid results, partly because it's in the wrong sector. If rotation continues, those are the kinds of names that could re-rate. Luna: That's a good concrete example. It's not a high-flying tech stock, just a steady business that's been overlooked. Lucas: Exactly. And I think that's the broader point. The market has been so bifurcated — the top 10 stocks in the S&P 500 account for over 35 percent of the index's weight. That's an all-time high. If that concentration starts to unwind, the beneficiaries won't just be the usual suspects. Luna: We should probably note that diversification isn't a free lunch. If tech rebounds, small caps could underperform again for a while. Lucas: Absolutely. Timing these rotations is nearly impossible. But I think the risk-reward is more balanced now than it's been in years. The VIX at 18.41 tells you people are paying up for protection. But the VVIX at 89 says they're not expecting a crash. That's a decent environment for patient investors to start looking outside the mega-caps. Luna: Speaking of patience, I think we should take a quick moment here. If conversations like this have helped you think about your portfolio or your career decisions, there's a small way you can support the show. Lucas: Yeah, it's the simplest thing. If today's episode was worth a coffee to you, that's the link — buy me a coffee dot com slash fexingo. No ads, no sponsors, just listener support keeping us independent. Luna: And we really appreciate that. It makes a difference. Lucas: It does. So back to the market — I want to touch on one more thing. The bond market is also signaling something interesting. The 30-year Treasury yield is at 4.86 percent, still above the 10-year, which is normal. But the 3-month yield is at 3.84 percent, which is well below the 10-year. That's an upward-sloping curve, which is historically bullish for risk assets. Luna: So the bond market is saying the economy is okay, not heading for recession. That supports the small-cap rally. Lucas: It does. But I'd caution against reading too much into any one indicator. The yield curve has been wrong before. The best approach is to look at the convergence of signals: lower rates, steepening curve, reasonable valuations, and a rotation out of overconcentrated tech. That's a plausible setup for small caps to continue outperforming. Luna: What would break that setup? What would make you change your mind? Lucas: Two things. One, a sharp rise in oil prices due to geopolitical events — the Strait of Hormuz closure was a risk we discussed a few episodes back. That would hit small caps hard because they're more energy-sensitive. Two, an earnings recession in the second half of 2026. If companies start missing guidance broadly, small caps will fall the most. Luna: So it's a conditional call. It's not a blanket buy signal. Lucas: Exactly. But I think it's a signal worth paying attention to. Markets are always telling you something. Right now, they're saying the baton is being passed. Whether the new runner can keep up is the question. Luna: Good way to put it. Thanks, Lucas. Lucas: Thanks, Luna.