Latest / Bull Market Conversations with Fexingo: Rallies, Momentum, and Riding Market Strength / The Russell 2000 Is Quietly Building a New Leadership Role
Transcript
- Lucas: The Russell 2000 is up three point four percent in the past five trading days. The S&P 500? One percent. That gap has been widening for weeks, but I think a lot of investors are still writing it off as a short-term rotation. Luna: Which is funny because the numbers are pretty clear. Small caps have been leading for a while now. But the narrative always seems to be 'it's just a catch-up trade.' Lucas: Right — and sometimes that's accurate. But look at the context. The Russell is up three and a half percent in five days and over twelve percent year-to-date. The S&P is up about nine percent. This isn't a one-week fluke. Luna: And honestly, if this show helps you think about a market move like that more clearly — maybe you catch something you would have missed — then it's worth a coffee. If today was worth a coffee to you, the link is buy me a coffee dot com slash fexingo. No pressure, just a way to keep this thing ad-free. Lucas: Yeah. We're not going anywhere, but listener support is what lets us keep the show exactly like this. So if that resonates, it's there. Back to the Russell — what's really driving it? Lucas: One factor: interest rates. The Fed funds rate has been flat at around three point six four percent since April. The market is pricing in no major moves for the rest of the year. For small caps, which carry more floating-rate debt, that stability is a big deal. Luna: Especially compared to last year when rates were still rising. Small companies got crushed because their borrowing costs kept going up. Now that rates are steady, the pressure is off. Lucas: Exactly. And there's another angle — domestic revenue exposure. The Russell 2000 generates roughly eighty percent of its revenue inside the U.S. Large caps are more global. Given the trade headlines we've been seeing — Huawei, APEC, the U.S.-China tensions — that domestic focus is a tailwind. Luna: So if you're worried about tariffs or supply chain disruptions, small caps look safer. Lucas: Right. But it's not just defensive. The Russell is heavily weighted toward financials, health care, and industrials — sectors that are performing well. The largest sector is financials at about eighteen percent. Regional banks, insurance companies — they benefit from a stable yield curve. Luna: And we saw the yield curve steepen a bit in April and May. That's usually a good sign for small caps. Lucas: Yeah. So structurally, the ingredients are there. But I want to talk about valuation, because that's the pushback I hear most. Some people say small caps are expensive relative to history. Luna: The price to earnings ratio on the Russell is around twenty-two times forward earnings. That's above the ten-year average of about eighteen times. But it's not crazy. Lucas: And if you compare it to the S&P 500's forward P/E of twenty-three times, the spread is actually narrower than usual. Small caps aren't a screaming bargain, but they're not overvalued relative to large caps either. The real question is whether earnings can catch up. Luna: That's the key. If small cap earnings growth accelerates in the second half of 2026, then the current multiple is justified. If it disappoints, you could see a correction. Lucas: And earnings so far have been mixed. About fifty-five percent of small caps have beaten estimates this quarter, which is in line with the long-term average. But the magnitude of beats is smaller than large caps. So the margin for error is thinner. Luna: Yet the market is still rewarding them. ARKK, the Ark Innovation ETF, is up two and a half percent in the past five days. That fund is heavily small cap and growth-oriented. Lucas: And Palantir, which is in a lot of small cap growth indexes despite its size, is up one point three percent. Not as dramatic, but still positive. The point is — money is flowing into risk-on assets broadly, but the smaller names are getting an extra boost. Luna: One thing I keep thinking about: if the economy slows down — real GDP growth is already down to two percent annualized — small caps are usually the first to feel it. They have less pricing power, less cash reserves. Lucas: That's the bear case. But the counterargument is that the market is already pricing in a soft landing. The Fed is on hold. Inflation is moderating. Consumer spending is still okay. If that scenario holds, small caps could continue to lead. Luna: So what do you tell someone who wants to position for this? Buy the Russell iShares ETF? Or pick individual names? Lucas: I think for most people, the ETF is the smarter move. IWM, the iShares Russell 2000 ETF, gives you broad exposure. If you're going to pick stocks, you need to focus on companies with strong balance sheets and positive free cash flow. The Russell has a lot of unprofitable companies. Luna: About forty percent of companies in the Russell 2000 are not profitable. That's a lot of landmines. Lucas: Right. So you can't just buy the index blindly and expect it to work. But if you screen for quality — debt to equity below one, positive free cash flow, revenue growth above ten percent — you can find names that are really well positioned. Luna: And that's where active management or a good ETF factor screen comes in. Something like the iShares S&P Small-Cap 600 Value ETF, which screens for profitability. Lucas: Exactly. The important thing is not to dismiss this rally as noise. The data supports it — rates, revenue exposure, sector mix. It could be the beginning of a longer-term leadership shift. Luna: Or it could be a rotation that fades if the economy weakens. But right now, the trend is your friend. Lucas: One last thing — the Russell is still about ten percent below its all-time high from 2021. So there's room to run even if it's not a new high. The large cap indexes are much closer to their peaks. Luna: That asymmetry is interesting. Less downside risk if sentiment turns, more upside if the economy holds. Not a bad setup. Lucas: Alright — that's our take on the small cap rally. Next time, we'll look at whether this leadership can survive the summer doldrums. Thanks for listening.