Latest / Inflation and Your Money with Fexingo: Protecting Purchasing Power and Beating Inflation / Why Small Caps Are Beating Big Stocks in This Market
Transcript
- Lucas: So the Russell 2000 just wrapped up a week where it gained over three percent. The S&P 500? Essentially flat. That spread is the widest we've seen in about eighteen months, and it's worth asking what's behind it. Luna: Three percent in a week is pretty dramatic for small caps. Are we finally seeing the rotation people have been calling for? Lucas: Yeah exactly. And I think the trigger is pretty clear — it's the Fed's rate pause. The effective fed funds rate has been sitting around 3.63 percent since May, and the daily rate has barely budged. That stability is actually a bigger deal for small companies than it is for the giants. Luna: Because small caps are more sensitive to borrowing costs — they don't have the same access to cheap debt that a Microsoft or an Apple does. Lucas: Right. When rates are volatile, small caps get hammered because their cost of capital swings wildly. But when rates settle into a pause — even if they're elevated — those companies can plan. They can finance inventory, make hiring decisions, expand. And that's exactly what we're seeing in the data right now. Luna: If our money conversations have helped you think about a decision differently — maybe it's how you're handling your cash allocation, or how you're looking at that small cap position — it's worth mentioning that listener support is what keeps this show ad-free and independent. People who find value here can help out at buymeacoffee.com/fexingo. Lucas: Yeah, it's a small gesture that goes a long way. And honestly, it's what lets us dig into these shifts without any sponsorship pressure to simplify or hype things up. Luna: Absolutely. So back to the small cap rally — what's actually driving the earnings picture here? Because it's not just rate stability, right? Lucas: No, there's a second factor that I think is even more interesting. Small companies have been surprisingly good at maintaining pricing power through this inflation cycle. The CPI ticked up to 334.0 in May, core CPI at 336.1 — inflation is still sticky. But smaller firms, the ones that operate in niche markets or local services, they've been able to pass along cost increases more effectively than people expected. Luna: Huh, that's the opposite of the conventional wisdom. Usually you'd think big companies with brand loyalty have more pricing power. Lucas: That's the standard story, but it's breaking down. Large multinationals are getting squeezed by currency swings and global supply chain complexity. A small regional manufacturer? They can raise prices because their customers can't easily switch to a foreign supplier. They're essential to their local ecosystem. Luna: So the inflation 'winners' might be shifting from the mega-caps to the mid and small caps. That's a big portfolio implication. Lucas: It really is. And you can see it in the data — the Russell 2000 is up 3.1 percent in the last five days while the S&P 500 added just 0.3 percent. That kind of divergence usually signals a shift in market leadership. The question is whether it's a short-term rotation or something more structural. Luna: Well, the 10-year breakeven inflation rate bumped up to 2.31 percent — that's slightly higher than last week. So the market expects inflation to persist. If that's the case, small caps with pricing power could have a sustained advantage. Lucas: Exactly. The breakeven rate is essentially the bond market's inflation forecast. At 2.31 percent, it's above the Fed's target but not alarmingly high. That's a Goldilocks zone for small caps — enough inflation to let them raise prices, but not so much that the Fed has to hike again. Luna: Let's talk about the elephant in the room though — gold. It dropped nearly 3 percent this week, even though inflation is sticky. Normally gold rallies on inflation fears. Lucas: That's a really good point. Gold's at $4,215, down 2.8 percent. And the GLD ETF is down about the same. The usual narrative would be inflation up, gold up. But what we're seeing is that the dollar has been relatively stable, and real yields are still attractive. Gold doesn't pay a yield, so when real yields are positive, gold loses its appeal. Luna: So the market is essentially saying 'inflation is here, but not scary enough to flee to gold.' Instead, money is flowing into equities — specifically small caps. Lucas: Right. And the gold miners ETF, GDX, actually rose 1.7 percent this week. That's interesting because it suggests investors still want some commodities exposure, but they're choosing producers over the metal itself. Producers have earnings and dividends, so they're more like equities with a commodity kicker. Luna: Makes sense. So if you're an investor trying to protect purchasing power right now, small caps might be a better inflation hedge than gold or even large caps. Lucas: That's the thesis. But it's not without risks. Small caps are more volatile, and they're more sensitive to any economic downturn. If the job market softens or consumer spending drops, these are the companies that get hit first. Luna: And we've seen some mixed signals there. The jobs report last month was still hot, but there are whispers of cooling in certain sectors. Lucas: Right. The Fed is in a tough spot — they want to cut rates to support growth, but sticky inflation and a strong labor market keep them on hold. For small caps, that pause is actually a sweet spot. They don't need rate cuts; they just need stability. And that's what they've got for now. Luna: So the play might be to look at small cap ETFs or individual names with strong local pricing power? Or is it too late after the rally? Lucas: I wouldn't chase the three percent week. But I think the structural case is still intact. If you're underweight small caps relative to your long-term target, this could be a reasonable time to add. The key is to focus on companies with pricing power — think niche industrials, specialized healthcare services, regional banks that aren't overexposed to commercial real estate. Luna: Regional banks — that's an interesting call. They've been under pressure for years, but with rate stability, maybe they can start lending more aggressively. Lucas: Exactly. The regional banking index, the KBW Nasdaq Regional Banking Index, has actually been rallying too. It's all connected — lower uncertainty around rates unlocks activity across the small cap universe. Luna: So the big picture here is that the old playbook — buy large caps for safety, small caps for speculation — might need a rewrite. Lucas: I think so. Inflation is reshaping which parts of the market actually protect your purchasing power. And right now, the small caps are making a compelling case that they deserve a bigger role in a diversified portfolio. Luna: It'll be interesting to see if this rotation has legs. If the Fed eventually cuts, small caps could really take off. Lucas: That's the bull case. But even without cuts, stability alone might be enough to keep this trade alive for a while. Let's check back next month and see if the trend holds.