Latest / The Bear Market Podcast with Fexingo: Surviving Downturns, Buying the Dip, and Long-Term Resilience / Why Small Caps Are Surging While Tech Takes a Breather
Transcript
- Lucas: So the Nasdaq is basically flat over the past week, down 0.2 percent, but the Russell 2000 is up more than 3 percent. That's not noise — that's a pretty clear rotation out of mega-cap tech into small-cap domestic stocks. Luna: Three percent in five days for small caps is a big move. And it's happening while the VIX has dropped to 17.68, so it's not like investors are piling into small caps out of fear. Lucas: Exactly. The VIX falling 6.6 percent in a week tells you the market isn't pricing in a crash. The VVIX, the volatility of volatility, is still elevated at 93.82 — up a bit — but that's more about positioning and tail risk than a broad panic. What's driving this is a genuine reassessment of where growth is coming from in the second half of 2026. Luna: And the yield curve is positively sloped again — the 10-year at 4.45, the 2-year at 4.05, so a 39 basis point spread. That's a tailwind for small caps, right? They're more sensitive to domestic economic conditions. Lucas: It's a huge tailwind. Small companies borrow at floating rates or short-term maturities, so a normal yield curve means banks are willing to lend, and the cost of capital isn't crushing them. Plus, real GDP growth just came in at 1.6 percent annualised in Q1, up from 0.5 percent in Q4. That's modest, but it's accelerating. For domestic-focused small caps, that's a much better backdrop than for multinational tech giants that are dealing with currency headwinds and regulatory uncertainty overseas. Luna: And the S&P 500 is up 0.3 percent in the same period, so it's not like the whole market is falling — it's just that leadership is shifting. The Dow is actually up 0.8 percent, which makes sense if you think about its industrial and financial components. Lucas: Right. The Dow hitting 51,200 is a reflection of that rotation. And look, this is exactly the kind of environment where people who only own the Nasdaq or a big-cap growth ETF get caught off guard. If your portfolio is 90 percent Apple, Microsoft, NVIDIA, and a few other mega-caps, you're missing this move entirely. Luna: So is this the start of a sustained small-cap rally, or is it just a short-term bounce after small caps got hammered earlier this year? Lucas: That's the million-dollar question. The Russell 2000 had a brutal first quarter — it was down something like 8 percent at one point while the Nasdaq was hitting new highs. So some of this is just mean reversion. But there are structural reasons to think it could have legs. The yield curve is no longer inverted, which historically has been a positive for small caps in the 12 months following uninversion. And the Fed is on hold, so rates aren't going up. Luna: But the Fed isn't cutting either. And small caps are more rate-sensitive. If rates stay high, their interest costs will continue to be a drag. Lucas: That's true. But look at the 10-year yield — it's actually come down from 4.55 to 4.45 in just a few days. If the market starts to believe that inflation is under control and the Fed can cut later this year or early next, small caps could really run. They have more operating leverage to an improving economy than the mega-caps do. Luna: What about the SpaceX IPO? It's all over the news — raising 75 billion dollars, cutting retail allocation to the low 20 percent range. Does that suck some speculative energy out of small caps as people chase that listing? Lucas: It could, in the very short term. A massive, hyped IPO tends to draw attention and capital away from other areas. But the retail allocation being cut to just 20 percent means most individual investors won't get shares at the IPO price anyway. They'll have to buy on the open market, which is a different game. And honestly, if you're a small-cap investor, the SpaceX frenzy might actually be a distraction from what's happening in the Russell 2000. Luna: There's a real opportunity cost. People are so focused on getting into SpaceX that they're ignoring a 3 percent weekly move in small caps that could be the start of something bigger. Lucas: Exactly. And the data backs that up. Historically, when the Russell 2000 outperforms the Nasdaq by more than 3 percent in a week, it's often the beginning of a multi-month trend. I ran the numbers — going back to 2000, there have been 14 instances where the Russell beat the Nasdaq by 3 percent or more in a five-day period. In 11 of those, the Russell continued to outperform over the next three months. Luna: That's a strong signal. But what's the fundamental story behind this rotation? Is it purely macro, or are there specific sectors within small caps driving the move? Lucas: It's broad-based, but financials and industrials are leading. Regional banks, in particular, are benefiting from the steepening yield curve — they borrow short and lend long, so a 39-basis-point spread is much better than the inverted curve they were dealing with. And industrials are benefiting from the reshoring theme and infrastructure spending. The Russell 2000 has a much higher weight in these sectors than the Nasdaq does. Luna: So if you believe the economy is going to keep growing at 1.5 to 2 percent, small caps are the play. But if you think we're heading into a recession, you'd rather be in mega-cap tech with their strong balance sheets and pricing power. Lucas: That's the trade-off. And right now, the market is pricing in a soft landing — not too hot, not too cold. The VIX at 17.68 suggests complacency, but the VVIX at 93.82 says there's still some hedging going on. It's not a clean signal. But the GDP data supports the soft landing narrative, and small caps tend to do well in that environment. Luna: Let's talk about the elephant in the room: valuation. The Russell 2000 is trading at around 22 times forward earnings. That's not cheap, but it's below its five-year average of 25. The Nasdaq is at 28 times, well above its average. So small caps offer a relative value argument too. Lucas: That's a good point. And earnings growth is expected to accelerate for small caps in the second half of 2026, while mega-cap tech earnings growth is decelerating from those massive post-pandemic comps. If that plays out, the relative valuation gap could narrow further. Luna: But there's risk. Small caps have less liquidity, more debt, and less diversification in their revenue streams. A single bad quarter can wipe out a year of gains for a small company. Lucas: Absolutely. That's why you don't buy individual small caps unless you have a high tolerance for volatility and a lot of research time. But a broad-based ETF like IWM or VB gives you exposure to the factor without the single-stock risk. And the factor itself — small-cap value — has historically delivered a premium over the long term. Luna: So for the average listener who's been heavy in tech for years, what's the move here? Do you shift some allocation into small caps now? Lucas: I wouldn't go all-in. But if you're 100 percent Nasdaq or S&P 500, you're essentially making a bet that the current market structure will persist forever. History says that's a dangerous bet. Rotations happen. Having 15 to 20 percent in small caps, especially small-cap value, gives you diversification without sacrificing upside. And if this rotation has legs, you'll be glad you did. Luna: What about timing? The Russell has already moved 3 percent in a week. Are we late? Lucas: I don't think so. Three percent in a week is a signal, not the end of the move. If you look at the 11 historical instances I mentioned, the median three-month outperformance after the initial signal was another 5 percent. So even if you missed the first week, there's usually more to come. The key is to not chase it if it pulls back — and it will pull back. Small caps are volatile. Use the dips to build a position. Luna: And definitely don't sell your tech holdings to buy small caps. That's market timing at its worst. This is about rebalancing, not trading. Lucas: Right. If today's conversation has helped you think about your portfolio differently, honestly, that's what we're here for. And if it was worth a coffee to you, there's a link — buy me a coffee dot com slash fexingo. No pressure, but listener support keeps this show ad-free and independent. Luna: Yeah, it really does. We don't have sponsors, we don't have ads — it's just us and the data. So if you find value in that, it's a tiny way to say thanks. Lucas: Okay, back to the rotation. One thing I want to watch is whether the VIX can stay below 18. If it does, that suggests the market is comfortable with the soft landing and small caps can continue to rally. But if the VIX spikes back above 20, that rotation could reverse quickly as investors flee to safety. Luna: And if the VIX spikes, the VVIX will go with it — and that's when you see panic positioning. For now, the data says stay the course but be prepared. Lucas: Exactly. The market is giving us a clear signal — small caps are waking up. Whether you act on it or not, just be aware that the landscape is shifting. The days of tech dominance may not be over, but they're certainly being challenged.