Latest / Bull Market Conversations with Fexingo: Rallies, Momentum, and Riding Market Strength / Why the Russell 2000 Is Outpacing the S&P 500 by 2x in May
Transcript
- Lucas: So the Russell 2000 is up three point six percent over the past five days. The S&P 500? One point two percent. That's not a small gap — that's small caps outperforming large caps by a factor of three. Luna: And this isn't a one-week fluke, either. The Russell has been on a tear for most of May. What's driving it? Lucas: A few things, but let's start with rates. The Fed's effective rate is still at three point six four percent, and they're clearly on hold. That's a huge deal for small caps because they're more sensitive to borrowing costs — they carry more floating-rate debt than large caps. When rates stay flat, their interest expense doesn't spike, and that margin relief shows up in earnings. Luna: Right, and the other big factor is domestic exposure. Small caps get most of their revenue from inside the US, so they're less exposed to the tariff noise and the strong dollar headwind that's been hitting multinationals. Lucas: Exactly. The dollar has been drifting lower this month, which actually helps small caps that export, but the bigger story is that they don't have to worry about currency translation losses the way, say, a company like Apple or Microsoft does. And with the S&P 500 heavily weighted toward global firms, that's a meaningful tailwind for the Russell. Luna: So what sectors within the Russell are leading? I know regional banks have been hot. Lucas: Regional banks are definitely one of them. The KBW Regional Banking Index is up sharply in May. When rates stabilize, banks' net interest margins stop compressing, and investors start pricing in better loan growth. Homebuilders are also strong — lower mortgage rates would be a catalyst, but even without a big drop, the demand for new housing is holding up. Luna: And the Russell has a lot of industrial and materials companies too, which tend to benefit from a weaker dollar and steady domestic demand. Lucas: That's right. So you've got this confluence: stable rates, a softer dollar, and an economy that's still growing at around two percent real GDP. That's a Goldilocks scenario for small caps. The Russell is up almost ten percent year-to-date, while the S&P is up about seven. The gap is real. Luna: I want to ask about valuations. Small caps are usually cheaper on a price to earnings basis, but after this run, are they still cheap? Lucas: That's the key question. The Russell is trading at about eighteen times forward earnings, which is above its five-year average of around sixteen. So it's not dirt cheap anymore, but compared to the S&P's twenty-two times, it's still a discount. And if earnings continue to improve — especially in financials and industrials — that multiple could be justified. Luna: You mentioned earnings. What are you seeing in terms of small-cap earnings revisions? Lucas: They've been trending up since April. Analysts are raising estimates for Russell 2000 companies at a faster clip than for the S&P. That's a healthy sign. It means the rally isn't just multiple expansion — there's actual fundamental improvement behind it. Luna: Before we go deeper, I want to take a quick step back. You know, conversations like this — where we unpack what's actually moving markets — are exactly why people listen. And it's why we keep the show ad-free. Lucas: Totally. If these episodes help you think about a decision differently, or give you a framework you didn't have before, that's the goal. And listener support is what keeps it going — a couple of dollars a month genuinely makes a difference. Luna: Yeah, it's buy me a coffee dot com slash fexingo. No pressure, but if you've gotten value from the show, it's a simple way to keep us rolling. Back to the Russell — what's the risk here? Lucas: The biggest risk is a rate hike. If inflation reaccelerates and the Fed has to move, small caps would get hit hard because of that floating-rate debt. Also, if the economy softens more than expected, the Russell's earnings could disappoint quickly. Luna: So it's a bet on the soft landing continuing. Lucas: Exactly. And so far, the data supports that. Real GDP growth just came in at two percent annualized, up from zero point five in the prior quarter. That's a meaningful acceleration. The labor market is still generating jobs. Consumer spending is holding up. The soft landing narrative is intact. Luna: What about the ETF flows? Are investors actually putting money into small-cap funds? Lucas: Yeah, IWM — the iShares Russell 2000 ETF — has seen net inflows of about two billion dollars in May. That's a vote of confidence. And the options market is pricing in more upside, with call volume elevated relative to puts. Luna: So sentiment is bullish. But is there a risk that too much money has already piled in? Lucas: That's always a concern. When everyone's already on the trade, the easy money is made. But I'd argue we're still in the middle innings. The Russell underperformed for most of 2024 and early 2025, so this catch-up trade has room to run, especially if earnings keep improving. Luna: What about the broader market context? The NASDAQ is up one point five percent in the past five days, the Dow one point three. The Russell's three point six percent is clearly the standout. Lucas: And the NYA, the New York Stock Exchange composite, is only up one point one percent. So the leadership is squarely in small caps. The question is whether this is a rotation or just a tactical move. Luna: What's your take? Lucas: I think it's a rotation. Large caps have been the leaders for years, especially tech. But with rates stabilizing and the economy broadening out, investors are looking for value and growth where they can find it. Small caps offer both — cheaper valuations and more sensitivity to domestic growth. Luna: So for someone listening who's mostly in index funds tracking the S&P, what should they do? Lucas: I'd consider adding some small-cap exposure. Not necessarily a huge overweight, but maybe five to ten percent of your equity allocation in a Russell 2000 ETF or a small-cap value fund. Just be aware of the volatility — small caps can drop twice as fast as large caps in a selloff. Luna: But if you have a longer time horizon, the return potential is higher. Lucas: Exactly. Over the past twenty years, small caps have outperformed large caps in about sixty percent of rolling five-year periods. It's not a guarantee, but the odds are in your favor if you can stomach the bumps. Luna: Let's talk about individual stocks for a second. CrowdStrike is down zero point seven percent in the past five days, and Datadog is up four point five. Does that tell us anything about the rotation within small and mid caps? Lucas: CrowdStrike is actually a large cap now — it's over sixty billion market cap. But Datadog at around forty billion is more mid-cap. The fact that Datadog is rallying hard while CrowdStrike is flat suggests that investors are still favoring growth at a reasonable price, but they're being selective. Datadog's earnings were strong, and its revenue growth is accelerating. Luna: And Palantir is down three point four percent. That's a notable laggard. Lucas: Palantir has had a huge run this year, so some profit-taking is natural. But it also shows that the AI trade is cooling a bit. The market is rotating away from pure hype and toward companies with more concrete fundamentals. That favors small caps in industries like manufacturing, finance, and healthcare. Luna: So the takeaway is: the Russell 2000 is leading, and it's backed by rate stability, earnings momentum, and domestic exposure. But stay diversified. Lucas: Exactly. The bull market is broadening, and that's healthy. The question is whether it can sustain. For now, the data says yes.