Latest / The Bear Market Podcast with Fexingo: Surviving Downturns, Buying the Dip, and Long-Term Resilience / Why the Russell 2000 Smalls Caps Are Surging While Tech Dips
Transcript
- Lucas: There is a fascinating divergence happening under the hood right now, and I want to zoom in on what the Russell 2000 is telling us that the Nasdaq simply isn't. Luna: You mean the fact that small caps are up over three percent in the last five days while the Nasdaq is basically flat? Lucas: Exactly. The Russell 2000 closed at 2,944 on Friday, up 3.1 percent for the week. Meanwhile the Nasdaq is down 0.2 percent. The S&P 500 is up 0.3 percent. So the real action is clearly in smaller names. Luna: And the VIX dropped over six percent to 17.68. So fear is easing, but the market is rotating, not just rallying across the board. Lucas: Right. The VIX at 17.68 is still above its long-term median around 16, but it's come down a lot from where it was a few weeks ago. The VVIX, which measures volatility of volatility, is at 93.8 — still elevated but not panicked. Luna: So what's driving this rotation? Is it just the rate picture? Lucas: That's a big part of it. The 10-year Treasury yield dropped to 4.45 percent last week, down from 4.55. The two-year yield fell to 4.05. So the yield curve is still positively sloped, about 39 basis points between the 10-year and the two-year. That's supportive for small caps because they tend to be more sensitive to borrowing costs. Luna: Smaller companies rely more on floating-rate debt and bank loans, so lower yields directly improve their earnings outlook. Lucas: Exactly. And the macro backdrop is actually improving. Real GDP growth came in at an annualized 1.6 percent for the first quarter, up from 0.5 percent in the prior quarter. That's not booming, but it's a meaningful acceleration. And nominal GDP is above 31.8 trillion. Luna: So the economy is growing, rates are coming down, and investors are looking beyond the megacap tech names that have dominated for so long. Lucas: Yes. And this rotation has historical precedent. If you go back to early 2024, we saw a similar move where the Russell 2000 outperformed the Nasdaq by a wide margin for several weeks. That was also a period when the 10-year yield fell from around 4.7 to 4.3. Luna: And what happened next? Did small caps keep leading? Lucas: For a while, yes. But then the AI trade reignited and tech took back the lead. So the question is whether this time is different. The market is much more top-heavy today than it was two years ago. Luna: Right. The top five stocks in the S&P 500 account for something like 25 percent of the index. That concentration makes any rotation out of tech a bigger deal for the broader market. Lucas: And it also means that if small caps truly take over as the leadership group, the Russell 2000 could have more room to run because it's been underperforming for so long. Year-to-date through last week, the Russell was up maybe 6 percent, while the Nasdaq was up more than 10. So catch-up potential exists. Luna: But there's also a risk. Small caps are more exposed to domestic economic weakness. If GDP growth falters again, they get hit harder than big multinationals. Lucas: That's the classic double-edged sword. The 1.6 percent growth rate is still below trend. The economy isn't exactly firing on all cylinders. So the rally in small caps could be a leading indicator that the soft landing narrative is gaining traction, or it could be a head fake if growth slows again. Luna: What about the valuation piece? Small caps are cheaper than large caps on a price to earnings basis, but they're not dirt cheap. Lucas: No, they're not. The Russell 2000 trades at about 15 times forward earnings, while the S&P 500 is around 21. So there is a discount, but it's not extreme. Historically, the discount has been wider during recession scares. So the current level suggests investors are cautiously optimistic but not euphoric. Luna: That's probably healthy. Euphoria in small caps usually ends badly. Lucas: Agreed. And one more data point: the VIX at 17.68 is consistent with moderate turbulence, not a crisis. In 2020, when the VIX was above 30, small caps collapsed. So the current volatility regime is actually favorable for risk-taking in smaller names. Luna: So if someone is listening and they've been all-in on Nasdaq megacaps, what should they be thinking about? Lucas: I'd say look at your diversification. If your portfolio mirrors the S&P 500, you have a massive overweight to tech and a tiny exposure to small caps. A 5 or 10 percent allocation to a Russell 2000 ETF could make sense if you believe the rotation has legs. But don't chase the three-day move. Luna: Good point. And for those who want to stay in tech, the Nasdaq pullback is only 0.2 percent over five days. That's hardly a correction. So it's not like tech is crumbling. Lucas: No, it's more of a pause. The Nasdaq is at 25,889, which is still near all-time highs. The rotation is happening without a major selloff in tech, which is actually a healthy sign. It means money is moving, not fleeing. Luna: Let's talk about the yield curve for a sec. The 10-year minus 2-year spread is 39 basis points, which is positive but quite flat. Historically, when the curve steepens from here, it's been good for small caps. Lucas: Yes. A steepening curve typically signals that the market expects growth and maybe some inflation. That environment favors cyclical and value stocks, which are overrepresented in the Russell 2000. Financials, industrials, consumer discretionaries — these are the sectors that do well when the curve steepens. Luna: And right now, the 30-year Treasury yield is at 4.95 percent, still above the 10-year. So the long end is pricing in some term premium, but not panic. Lucas: Exactly. The bond market is saying the economy is okay but not great. And that's actually a sweet spot for small caps, because they benefit from moderate growth and low rates, but they don't need a boom. Luna: It's interesting. We've done a lot of episodes on the Nasdaq and the VIX, but the Russell 2000 divergence really does feel like the story of the moment. Lucas: It does. And I think we should keep watching it. If the Russell holds these gains and the Nasdaq starts to lag more meaningfully, that would be a real shift in market leadership. It's too early to call it a regime change, but it's worth paying attention to. Luna: Quick thought — you know, this kind of analysis is exactly why we keep this show ad-free. We don't have to sell you anything to talk about what we think matters. Lucas: That's right. We deliberately don't run ads. If you find value in these conversations and want to support that choice, there's a link: buy me a coffee dot com slash fexingo. No pressure, just if it helps. Luna: Yeah, exactly. Keeps us independent. Alright, back to the small-cap shift. Lucas: So what's the one key metric to watch to see if this rotation is real? I'd say the Russell 2000's relative strength versus the Nasdaq. If the ratio breaks above its 50-day moving average, that would be a technical confirmation. Luna: And fundamentally, keep an eye on the 10-year yield. If it stays below 4.5 percent, that tailwind for small caps remains. Lucas: Exactly. And the next big catalyst could be the Fed's next move. If they signal a rate cut later this year, small caps could really take off. But if inflation picks up and yields rise again, the rotation could reverse. Luna: So it's a game of patience. Watch the data, don't overreact to a few days of outperformance. Lucas: Right. The market is giving us a signal. Now we have to see if it sustains.