Latest / The Bear Market Podcast with Fexingo: Surviving Downturns, Buying the Dip, and Long-Term Resilience / Why the Russell 2000 Rally Could Keep Going in 2026
Transcript
- Lucas: The Russell 2000 is up 3.4 percent in the past five trading days. That's more than double the S&P 500's one percent gain over the same stretch. Luna: That's a pretty stark divergence. Is this just a catch-up move after large caps dominated for so long, or is something more structural going on? Lucas: I think it's a bit of both, but the data points to a genuine shift in market leadership. The S&P 500 is sitting at 7473, basically flat on the year after a strong 2025. Meanwhile the Russell has surged 3.4 percent in just a week, and it's been quietly outperforming for a couple of months now. Lucas: And if this episode has helped you think differently about where the market might be heading, honestly, if today was worth a coffee to you, that's the link — buy me a coffee dot com slash fexingo. It's what keeps this show ad-free. Luna: Yeah, listeners like you are the reason we can do deep dives without sponsors steering the conversation. It really does make a difference. Lucas: Alright, so back to the Russell. The key driver I'm watching is the yield curve. The 10-year yield is at 4.57 percent, the 2-year at 4.08, so the spread is about 43 basis points. That's actually down a bit from last week, but it's still in positive territory — and historically, a steepening yield curve tends to favor smaller companies. Luna: Because small caps are more sensitive to the economic cycle, right? They benefit more from a 'soft landing' scenario where growth holds up and rates maybe come down. Lucas: Exactly. Small caps tend to be more domestically focused and more leveraged to the economic cycle. If the market is pricing in a scenario where the economy avoids a recession and the Fed eventually cuts rates, that's a great setup for the Russell. The VIX dropping to 16.70 also supports that — lower fear, more appetite for risk. Luna: But isn't there a risk that this is just a 'catch-up' trade that's already played out? The Russell is up 3.4 percent in five days — that's a lot of momentum already priced in. Lucas: It's a fair concern. One way to gauge is to look at relative valuations. The S&P 500 trades at about 22 times forward earnings. The Russell 2000 is closer to 15 times. That's a discount that's wider than the historical average, so there's still room for multiple expansion if earnings hold up. Lucas: But valuation alone isn't a catalyst. What gives me more confidence is the sector composition of the Russell. It's heavily weighted toward financials, industrials, and healthcare — sectors that tend to do well when the yield curve is steepening and the economy is growing at a moderate pace. Luna: So it's not just about small caps being cheap — it's about the specific industries that dominate the index being in favor. Lucas: Right. The Russell has about 18 percent in financials, 16 percent in industrials, and 14 percent in healthcare. Compare that to the S&P 500, which is nearly 30 percent tech. If the macro narrative shifts from 'AI boom' to 'steady growth,' the Russell's makeup becomes a tailwind. Luna: What about the flip side? If we do get a recession, small caps usually get hit harder. Lucas: Absolutely. The Russell is more leveraged, both operationally and financially. Many small caps have variable-rate debt, so if rates stay higher for longer, their interest costs eat into margins. The 2-year yield has actually ticked up to 4.08 percent this week, which suggests the market isn't fully convinced the Fed is done hiking. Luna: So the rally could be fragile if the data turns sour. Lucas: Exactly. But look at the economic data we have: real GDP growth annualized at 2 percent, up from 0.5 percent. That's a meaningful acceleration. The job market is still solid. Consumer spending is holding up. So the base case isn't recession — it's moderate growth. And that's the sweet spot for small caps. Luna: One thing I noticed: the Russell is up 3.4 percent in a week, but the VIX is down 6.3 percent. That drop in volatility is consistent with a risk-on move, not a panic-driven short squeeze. Lucas: Good observation. A VIX below 17 is generally associated with complacency, but it also tends to precede further upside if the economic data cooperates. The VVIX, which measures volatility of volatility, is flat at 91 — so no sign of tail risk being priced in. Lucas: Let's put some numbers on it. The Russell 2000 is at 2869. To get back to its all-time high from late 2021, it would need to rally about 12 percent from here. That's achievable if earnings growth comes through and multiples expand modestly. Luna: But the index is still below its 2021 peak — so we're not talking about a market that's already priced for perfection. Lucas: Not at all. And that's part of the appeal. The S&P 500 is at all-time highs. The Dow hit 50,580 this week. The Nasdaq is at 26,344. Large caps have already recovered and then some. Small caps have been left behind. That catch-up potential is real. Luna: Is there a risk that this is just a 'relief rally' after a period of underperformance, and it fades once the initial enthusiasm wears off? Lucas: That's possible. But the duration of the move matters. This hasn't been a one-week wonder. The Russell has been outperforming the S&P 500 for about two months now. That's enough time to suggest a genuine rotation rather than a fleeting shift. Lucas: Another factor: merger and acquisition activity tends to pick up when small caps are cheap relative to large caps. Larger companies acquire smaller ones for growth. We've seen a few deals in the healthcare and tech spaces, and if that accelerates, it puts a floor under small-cap valuations. Luna: Right, because if you're a big company with a high stock price, you can use your shares as currency to buy smaller rivals at a discount. Lucas: Exactly. That's a classic late-cycle dynamic. And with the regulatory environment being somewhat unpredictable — there's talk of the government taking stakes in certain companies — but for now, M&A is proceeding at a healthy clip. Luna: What about the China headlines? The trade tensions haven't gone away. Could that hurt small caps more than large caps? Lucas: It's a mixed bag. Small caps are more domestic, so they're less exposed to China directly. But if trade tensions cause a global slowdown, no one is immune. The APEC signals suggest the U.S. and China are still far apart, so that's a risk to watch. Luna: So the bull case for small caps rests on: moderate economic growth, a steepening yield curve, reasonable valuations, and a rotation out of mega-cap tech. The bear case is: recession, higher for longer rates, or a renewed risk-off shock. Lucas: That's a fair summary. I'd add one more bullish factor: positioning. Many institutional investors are underweight small caps relative to benchmarks. If they start to rotate, there's a lot of money that could flow in. Luna: So it's not just about what's happened — it's about what could happen if conviction builds. Lucas: Exactly. And that's why this episode matters. We're not just looking at a 3.4 percent weekly move in isolation. We're asking whether it's the start of a sustained regime change. The data suggests it could be. Luna: But as always, the market has a way of surprising us. Lucas: It does. That's why we watch the data, not the headlines. And right now, the data is giving small caps a real chance to lead. Luna: So the question for investors becomes: do you chase the rally here, or wait for a pullback? Lucas: That's a personal decision based on your time horizon and risk tolerance. But for those with a long-term view, owning a diversified basket of small caps at a 15 times earnings multiple, with the economy growing at 2 percent and the yield curve normalizing, has historically been a pretty good bet.