Latest / The Bear Market Podcast with Fexingo: Surviving Downturns, Buying the Dip, and Long-Term Resilience / Why the Russell 2000 Rally Has Room to Run in Late 2026
Transcript
- Lucas: Luna, the Russell 2000 just posted a 3.4 percent gain over the past five days. That's more than double the S&P 500's move. And the VIX dropped to 16.59 — below 17 for the first time in weeks. Luna: That's a pretty clear risk-on signal. The last time we saw this kind of small-cap leadership was early April, right before the yield curve steepened again. Lucas: Exactly. And the curve has been doing something interesting. The spread between the ten-year and two-year Treasury is now 43 basis points. Down from 49 a few days ago, but still positive and relatively wide by recent standards. Luna: So the curve is normalizing — that's usually good for small caps. They tend to be more levered to domestic growth and more sensitive to credit conditions. Lucas: Right. When the curve flattens, banks get squeezed, and smaller companies often rely on bank lending. But with the ten-year at 4.57 percent and the two-year at 4.08, there's enough spread for banks to lend profitably. Luna: And the economic data backs that up. Real GDP growth just came in at an annualized 2 percent, up from 0.5 percent in the prior quarter. That's a meaningful acceleration. Lucas: It is. And if you look at the composition of the Russell 2000, about a third of those companies are in financials, industrials, and consumer discretionary — sectors that benefit directly from a firming economy. Luna: But there's also a geopolitical angle here. APEC just wrapped up, and the headlines suggest the U.S. and China are still far apart on trade. That uncertainty usually hits big multinationals more than domestically focused small caps. Lucas: That's a good point. The S&P 500 gets about 40 percent of its revenue from overseas. The Russell 2000 gets closer to 20 percent. So if trade tensions escalate, small caps could act as a relative safe haven. Luna: And yet we're seeing China tech stocks rally anyway. Huawei is planning new smartphone chips this fall, taking on Nvidia and Apple. That's a reminder that tech competition is alive and well. Lucas: It is. But for today's conversation, the small-cap story is really about domestic cyclical recovery. The question is whether the rally has legs. Historically, when the Russell outperforms the S&P by more than 2 percent in a week, it tends to signal a multi-month rotation. Luna: We saw that in late 2020 and again in early 2021. But the caveat is earnings. Small-cap earnings have been under pressure from higher input costs and wage inflation. Lucas: That's true. But the latest data shows that input cost pressures are easing. The PPI has moderated, and the employment cost index is growing at a slower pace. If margins stabilize, that could be a catalyst. Luna: Speaking of catalysts, the Fed is in a holding pattern. The FOMC minutes from the last meeting showed officials are comfortable with rates where they are. No cuts on the horizon, but no hikes either. Lucas: That's a stable backdrop for small caps. They don't need rate cuts — they just need rates to stop going up. And with the two-year yield basically flat at 4.08, the market seems to agree. Luna: So what's the bear case? If the economy slows again, small caps get hit harder because they have less pricing power and weaker balance sheets. Lucas: Absolutely. That's the risk. But the GDP data suggests we're accelerating, not slowing. And the yield curve, while flatter than a few months ago, is still positively sloped. That's a classic environment for small-cap outperformance. Luna: One more data point: the Russell 2000 is still about 8 percent below its all-time high from late 2021. So there's room to run before it gets stretched. Lucas: That's the kind of detail I think a lot of our listeners might find useful — understanding that this isn't a bubble yet. It's a catch-up trade. Luna: And if today was actually useful to you, the way these stay ad-free is listener support. If you want to keep that going, you can find us at buy me a coffee dot com slash fexingo. Lucas: Yeah, it really helps us keep doing these deep dives without any sponsor interruptions. So thank you to anyone who chips in. Luna: Alright, so back to the small-cap rally — what would you watch for next week to see if it sustains? Lucas: I'd look at the weekly jobless claims and the regional Fed manufacturing surveys. If those show continued strength, it's a green light. Also, keep an eye on the VIX. If it stays below 17, the risk appetite is intact. Luna: And if the VIX spikes back above 20, that rotation could reverse quickly. Lucas: Right. But for now, the data supports the bull case for small caps. The economy is growing, the curve is normal, and valuations aren't crazy. That's a decent setup. Luna: I think the key takeaway is that this isn't just a knee-jerk reaction. There's real fundamental support. Lucas: Exactly. And for investors who've been waiting on the sidelines, this might be the moment to consider adding small-cap exposure — but with the understanding that it's a cyclical bet, not a long-term secular one. Luna: Well said. Thanks, Lucas. Lucas: Thanks, Luna. Talk to everyone next time.