Latest / The Bear Market Podcast with Fexingo: Surviving Downturns, Buying the Dip, and Long-Term Resilience / How the Russell 2000 Is Beating Large Caps This Summer
Transcript
- Lucas: The Russell 2000 is up 2.7 percent in the last five trading days. The S&P 500 and the Nasdaq are basically flat. That is not a normal summer pattern. Luna: It feels like the narrative flipped overnight. Small caps were the unloved stepchild for most of the past two years. Lucas: Right. And we've seen this movie before — a sudden rotation into small caps that fizzles after a few weeks. But the data this time might actually be different. The VIX dropped 18.5 percent in that same five-day window, down to 16.2. Luna: So falling fear coincides with small-cap outperformance. That makes sense — small caps are more sensitive to the economic cycle, so when people get less scared, they rotate into riskier names. Lucas: Exactly. And it's not just the VIX. The VVIX — the volatility of the VIX — fell 8.6 percent to 87.6. When the VVIX is below 90, the market tends to be in a low-stress regime. Small caps love that. Luna: And the yield curve is steepening too. The 10-year Treasury yield is at 4.48 percent, the 2-year at 4.09 — that spread is 39 basis points, up from basically flat a few months ago. Lucas: A steeper curve is generally good for banks and small caps because it signals expectations of future growth. Regional banks are a big component of the Russell 2000, and they've been rallying on that steepener. Luna: So this feels like a genuine shift in market leadership, not just a dead-cat bounce in beaten-down small caps. Lucas: The question is whether it has legs. Historically, small-cap outperformance tends to last about six to nine months once the cycle turns. But we're only one week in. If you're listening and thinking about chasing this move — the data says wait for confirmation. Luna: What confirmation signals are you watching specifically? Lucas: I'm watching the Russell 2000's relative strength versus the S&P 500. If it can hold above its 50-day moving average for two consecutive weeks, that's a real trend. Also earnings — Q2 reports start in mid-July. If small-cap companies guide higher, that's the fundamental catalyst. Luna: And on the macro side, we have the GDP data from January — real GDP growth annualized at 1.6 percent, up from 0.5 percent in the prior quarter. That's a meaningful acceleration. Lucas: That's the kind of backdrop small caps need: moderate growth, not too hot, not too cold. And inflation seems to be cooling, which gives the Fed room to pause. The 3-month Treasury yield is flat at 3.78 percent — no pressure from the front end. Luna: If today's conversation helped you think about how to position your portfolio for a potential rotation, that's exactly why we do this show ad-free. And the way we keep it that way is listener support — buy me a coffee dot com slash fexingo. Lucas: Yeah, it's a small gesture that makes a big difference for us. No pressure, just if you find value in what we do here. Luna: Alright, back to the rotation. Lucas, you mentioned waiting for confirmation — but what about investors who want to get in early? Lucas: If you want to dip a toe in, I'd look at the iShares Russell 2000 ETF, ticker i w m. But don't go all in. The Nasdaq is still the dominant index — it's at 26,684, up something like 20 percent from a year ago. Small caps are trying to catch up, but they're still down from their 2021 highs. Luna: And the S&P 500 is at 7,554. That's not cheap by any measure. The price to earnings ratio on the S&P is around 22 times forward earnings. The Russell 2000 is closer to 15 times. So there's a value argument for small caps. Lucas: Valuation is one thing, but momentum is another. The Russell 2000 has a beta of about 1.1 relative to the S&P 500 — meaning it's more volatile. So if the market turns south, small caps could get hit harder. Luna: You mentioned banks earlier — regional banks are about 15 percent of the Russell 2000. How are they doing? Lucas: They've been on a tear this week. The KBW Regional Banking Index is up about 3 percent in five days. The steepening yield curve helps their net interest margins. And there haven't been any new bank failures or scares, so sentiment is improving. Luna: So if I'm a long-term investor with a diversified portfolio, do I need to own small caps? Lucas: Historically, yes. Over the last 20 years, small caps have outperformed large caps in about 40 percent of rolling five-year periods. But they go through long stretches of underperformance. If you have a 10-year horizon, having 10 to 15 percent in small caps makes sense. Luna: But not if you're going to panic and sell them when they drop 30 percent in a downturn. Lucas: Exactly. Small caps are not for the faint of heart. In 2022, the Russell 2000 fell 21 percent. The S&P fell 19 percent. So the drawdowns are steeper. You need conviction. Luna: What about the SpaceX IPO? That's been all over the news. Does that affect the small-cap narrative? Lucas: Not really. SpaceX is a mega-cap private company going public, but it's not in any small-cap index. It's a reminder that retail investors are hungry for new names, but the real action in small caps is in more mature, profitable companies. Luna: Like which ones? Lucas: Take a company like Simpson Manufacturing, ticker s s d. It's a small-cap that makes engineered wood connectors. It's boring, it's profitable, and it's up about 8 percent this week. That's the kind of name that benefits from a housing recovery and a steepening curve. Luna: So the play is not just any small cap — it's small caps with earnings and a catalyst. Lucas: Right. Avoid the unprofitable tech wannabes. Focus on value-oriented small caps in industries like industrials, financials, and materials. Those are the ones that rally when the yield curve steepens. Luna: And how do we know if this rotation is real? What's the one number we should watch? Lucas: Watch the Russell 2000's 50-day moving average versus its 200-day moving average. If it crosses above — a golden cross — that's a technical buy signal. It hasn't happened yet, but it's getting close. Luna: And if it doesn't happen? Lucas: Then this week was just a summer fling. But given the macro backdrop — falling VIX, steepening curve, moderate GDP growth — I think there's more room to run. Luna: Alright, we'll keep watching. Thanks, Lucas. Lucas: Thanks, Luna. That's all for this episode. Stay grounded, and we'll talk next time.