Latest / Bull Market Conversations with Fexingo: Rallies, Momentum, and Riding Market Strength / Why the Bull Market Is Ignoring the Russell 2000
Transcript
- Lucas: So the S&P 500 is up about 11 percent year-to-date in 2026. The NASDAQ has done even better. But the Russell 2000 — that's the small-cap index — it's basically flat over the same period. Actually, over the last five days, the Russell is up 0.3 percent while the S&P is down 0.8 percent. That's not catching up, that's just less bad. Luna: Right, and the five-day is noise. The real story is the persistent gap. I've been looking at the relative performance chart and it's striking — small caps have been dead money for nearly two years. Lucas: Exactly. And the question I keep getting from listeners is: why? If this is a bull market, shouldn't smaller, more agile companies benefit more from a growing economy? GDP growth just came in at 2.1 percent annualized for Q1 2026, up from 0.5 percent the quarter before. That's objectively good. Luna: So what's the number one reason they're being left behind? Lucas: I'd say it's the Fed. The effective fed funds rate is at 3.63 percent and the Dallas Fed president just called for 'modestly' higher rates. Small companies carry a lot more floating-rate debt than large caps. When rates stay higher for longer, their interest expense eats into earnings much more aggressively. Meanwhile, a company like Apple or Microsoft has fortress balance sheets and can issue fixed-rate debt at attractive spreads. Luna: And their earnings are more domestic. Small caps generate almost all their revenue inside the U.S., which means they're fully exposed to whatever happens with consumer spending and domestic demand. Mega-caps get half their revenue from overseas, so they can diversify currency and growth risks. Lucas: That's the second reason. The third is passive flows. Most of the money pouring into index funds goes to the S&P 500 or the NASDAQ. The Russell 2000 ETF — ticker i w m — has seen net outflows in five of the last six months. That's a self-reinforcing cycle: no inflows means no price support, which means underperformance, which scares away more money. Luna: It's a bit of a doom loop. And there's a sentiment angle too. Small caps are seen as riskier, and in a market where the top ten stocks account for over 30 percent of S&P 500 weight, investors are saying 'why take the risk when the safe bet keeps working?' Lucas: Right. But there is one corner of small caps that is actually working, and it fits a theme we've talked about before: cybersecurity. CrowdStrike is up 8 percent in the last five days alone. The stock trades at around $203, and it's one of the few mid-cap names that's getting bid up because the spending environment for security is just relentless. Luna: CrowdStrike isn't technically a small cap — it's around a $50 billion market cap — but it shows where the money is going. Anything tied to AI infrastructure, cybersecurity, or cloud migration is getting a multiple expansion. Traditional small caps like regional banks, retailers, or manufacturers are getting crushed. Lucas: Let's dig into the regional bank example. The KBW Regional Banking Index is down about 8 percent year-to-date. Those banks are small-cap or mid-cap, they have huge exposure to commercial real estate loans, and their net interest margins are squeezed because they have to pay more for deposits while their loan portfolios are locked in at lower rates. That's a triple whammy. Luna: And the market is basically saying: we don't trust that those earnings will recover anytime soon. Meanwhile, a company like Datadog — which is a mid-cap at around $40 billion — is only down 0.6 percent in the last five days. It's not surging, but it's holding up because its revenue growth is still 25 percent plus. Lucas: So the bull market is not ignoring all small caps. It's ignoring small caps that look like the old economy. If you're a small-cap software company with recurring revenue and a big addressable market, you're fine. If you're a small-cap manufacturer or a regional bank, you're in trouble. Luna: That feels like a pretty big divergence. Does that usually happen in bull markets? Lucas: Historically, no. In a typical bull market, small caps lead in the early stages because they're more leveraged to economic recovery. But this cycle is unusual because the recovery was followed by the fastest rate hiking cycle in decades. Small caps never got their moment. Luna: And the market is pricing in that rates stay elevated. The fed funds futures curve doesn't show a cut until early 2027. So the headwind persists. Lucas: That brings us to a really interesting question: is this a buying opportunity or a value trap? If you believe the Fed will eventually cut, then small cap earnings could snap back hard. But if you think rates stay higher because the economy is actually running hot — and GDP growth of 2.1 percent supports that view — then maybe small caps deserve to be cheap. Luna: Honestly, if today's conversation was worth a coffee to you, that's the link — buy me a coffee dot com slash fexingo. It's how we keep this show ad-free and focused on the numbers that matter. Lucas: Yeah, and we mean that. If you've gotten one actionable idea from this episode, that's all it takes. We don't run ads, we don't do sponsorships, it's just listener support. So thank you. Luna: Alright, but back to small caps. Lucas, you mentioned the possibility of a catch-up trade. What would have to happen for that to materialize? Lucas: Two things. First, we need a catalyst that shifts investor sentiment away from mega-cap tech. That could be a regulatory crackdown, a big earnings miss from one of the leaders, or a rotation into value. Second, we need some sign that small cap earnings are stabilizing. The Q2 earnings season is just starting, and we're seeing a few regional banks beat low expectations. If that continues, it could be a turning point. Luna: But you're not betting on it yet. Lucas: I'm not. I'd want to see at least two consecutive quarters of small cap earnings growth outpacing large cap before I got excited. And I'd want to see the Russell 2000 start to show relative strength on a technical basis. Right now, it's still making lower highs against the S&P. Luna: So for the average listener who wants exposure to small caps but doesn't want to stock-pick, what's the play? Lucas: I'd look at a quality-focused small cap ETF, something like the iShares S&P Small-Cap 600 Growth ETF — ticker I-J-T — which screens for profitability and earnings momentum. It's outperformed the plain Russell 2000 by about 4 percent year-to-date. You pay a slightly higher expense ratio, but you get companies that actually make money. Luna: And avoid the broad-based Russell 2000 ETF for now? i w m? Lucas: Correct. i w m includes a lot of unprofitable companies that are getting hammered by higher rates. If you want small caps, you have to be selective. The days of just buying the index and waiting are over, at least until the rate environment changes. Luna: That's a pretty sobering take for small cap bulls. But it's grounded in the data. The Russell is at 2,962 today — that's basically where it was in early 2024. Two years of zero return. Lucas: Meanwhile the S&P is up over 20 percent in that same period. That's a massive wealth transfer from small cap shareholders to large cap shareholders. And I don't see it reversing until the Fed changes its tune. Luna: Which, based on the latest commentary from Dallas Fed President Logan, doesn't seem imminent. She called for 'modestly' higher rates just this week. Lucas: Right. So the bull market is alive and well, but it's a narrow one. And if you're not in the right names, you're not participating. That's the uncomfortable truth for July 2026. Luna: Alright, let's leave it there. For Fexingo's Bull Market Conversations, I'm Luna. Lucas: And I'm Lucas. We'll be back tomorrow with another angle on this market.