Latest / The Bear Market Podcast with Fexingo: Surviving Downturns, Buying the Dip, and Long-Term Resilience / Small Caps Are Beating Tech in 2026 Here Is Why
Transcript
- Lucas: So the Russell 2000 just closed its best first half in thirty-five years. We're talking a small-cap index that's up nearly twelve percent since January, while the Nasdaq is barely positive if you strip out a handful of AI stocks. Luna: Thirty-five years? That puts us back to the early '90s. What changed? Lucas: Look, a few things. First, the market is finally betting that the Fed is done hiking. The two-year yield dropped to four point zero seven percent this week, the ten-year is at four point three eight. That's a steepening curve — typically good for small caps because they borrow more and benefit from a stronger economy. Luna: Right. But Hammack from Cleveland Fed just said AI could fuel inflation and rate hikes might be necessary. That seems to push the other direction. Lucas: It does, and that's the tension. But the market priced that comment in and still rallied. The VIX dropped to sixteen point six eight — down over ten percent in five days. That's not a market expecting a hawkish surprise. Luna: Quick honest thing — we don't run ads on this show. A handful of listeners chip in monthly through buy me a coffee dot com slash fexingo, and that's literally what funds making this many episodes. If our money conversations have helped you think about a decision differently, that link is there. Lucas: Yeah. It's not a big ask — just mentioning it because listener support is the only reason we stay independent. So, back to small caps: the real driver isn't just rates. It's earnings. Small-cap earnings per share are projected to grow faster than large-cap this year for the first time since 2021. Luna: And that's partly due to domestic exposure. Small caps generate about eighty percent of revenue inside the US, so tariffs and reshoring actually help them. The big tech names are vulnerable to global trade tensions. Lucas: Exactly. The Russell is up one point three percent in the last five days alone, while the Dow is basically flat. The S&P 500 is up, but it's carried by a few mega-caps. The breadth of this rally is what's interesting. Luna: So is this a genuine rotation or just a catch-up trade after years of underperformance? Lucas: That's the million-dollar question. The last time small caps outperformed this decisively was the early 2000s. After the dot-com bust, the Russell 2000 beat the S&P 500 for six straight years. Value investing came back. Luna: And we had a similar setup: the Fed cutting rates after a hiking cycle, a weak dollar, and a focus on domestic manufacturing. It's not a perfect parallel, but the pattern is there. Lucas: Right. The difference today is that mega-cap tech isn't in a bust. Apple, Microsoft, NVIDIA — they're still printing cash. But their valuations are stretched. The S&P 500's price to earnings ratio is over twenty-three. The Russell is at around sixteen. Luna: So cheaper stocks with better earnings momentum. That's a classic value case. Lucas: It is. And there are specific sectors driving it. Regional banks are up big — the KBW Regional Banking Index is up eighteen percent this year. Those stocks were hammered in 2023 after the Silicon Valley Bank failure. Now they're recovering as deposit costs stabilize. Luna: Homebuilders too. The iShares Home Construction ETF is up over twenty percent. Low existing-home inventory plus falling mortgage rates is a tailwind. Lucas: And industrials. Companies that make things in America — machinery, tools, electrical equipment — are benefiting from the CHIPS Act and infrastructure spending. That's mostly small and mid-cap. Luna: But there's a counterargument. The yield curve is still inverted — ten-year minus two-year is only twenty-eight basis points. Historically, small caps don't lead until the curve is positively sloped and staying that way. Lucas: That's true. And the VIX at sixteen point six eight is low, but not extremely low. If volatility spikes again, small caps tend to get hit harder because they're less liquid. Luna: So you're saying this rally has legs, but it's fragile. Lucas: I think it has more room to run, but it won't be a straight line. The key is whether the Fed actually cuts rates this year. Right now the market is pricing in two cuts by December. If Hammack's view wins out and they hold steady, small caps could stall. Luna: What about the investor who's been all-in on tech? Do they shift now? Lucas: I'd say don't dump your NVIDIA shares to buy a basket of regional banks. But adding a small-cap ETF — like the iShares Russell 2000 ETF or the Vanguard Small-Cap Value ETF — is a reasonable diversifier. You're getting exposure to the domestic economy at a cheaper valuation. Luna: And if you're worried about a recession? Lucas: Small caps are actually more sensitive to recession because they have thinner margins and more debt. So if growth slows, they'll underperform. But the real GDP growth number just came in at two point one percent annualized — that's not recession territory. Luna: It's a soft landing narrative, and small caps historically rally hard in soft landings. Lucas: Exactly. In the 1994-1995 soft landing, the Russell 2000 gained over thirty percent in the twelve months after the last rate hike. So the playbook says buy small caps now. Luna: But the playbook also said buy bonds in 2022. We know how that ended. Lucas: Fair point. No playbook is perfect. But the data today is supportive. The small-cap index is at three thousand twenty-five, up one point three percent in five days. The VIX is falling. The yield curve is steepening. The earnings picture is improving. Those are facts. Luna: So what's the one thing you'd tell a listener to take away? Lucas: Don't ignore small caps. They've been the ugly duckling for years, but they're having a moment. If you're building a long-term portfolio, a small-cap allocation makes sense here — not as a bet, but as a hedge against the mega-cap concentration that's dominated the last decade. Luna: And if you're a trader? Lucas: Watch the VIX. If it stays below seventeen, the risk-on trade is alive. If it spikes back to twenty, small caps will be the first to fall. Set stops, take profits, don't get greedy. Luna: Alright. So small caps are back — for now. Let's see if they can hold it through earnings season. Lucas: That's the test. The Russell's performance in July will tell us a lot. If earnings confirm the optimism, this could be the start of a multi-year run. If not, it's just a summer fling.