Latest / The Bear Market Podcast with Fexingo: Surviving Downturns, Buying the Dip, and Long-Term Resilience / How the Small Cap Index Holds Up When Giants Fall
Transcript
- Lucas: The S&P 500 is down one point three percent over the past five trading days. The Nasdaq has dropped nearly three percent. But the Russell 2000, the small cap index, is actually up, barely, but up — by a tenth of a percent. Luna: So small caps are holding water while the big tech names take a hit. That's not something we've seen much of in the last couple years. Lucas: Exactly. And I think it's worth asking whether this is just a brief rotation or the start of a more structural shift. Because for most of the recovery from 2023 through 2025, big caps dominated. The Nasdaq and the S&P 500 were the engines of the rally, and small caps lagged badly. Luna: Right, and the Russell actually underperformed the Nasdaq by something like twenty percentage points over that stretch. So what changed? Lucas: Look, one thing that matters is the yield curve. The ten-year minus two-year spread is now thirty-one basis points, up from thirty the day before. That's still a very flat curve, but it's steepened meaningfully from the inverted levels we saw in 2023 and early 2024. Luna: And a steeper curve tends to be good for banks and for smaller companies that rely on borrowing. Because they can actually earn a spread on lending. Lucas: That's part of it. Another piece is that the economic data, at least the real GDP figures, still show growth. Real GDP came in at two point one percent annualized for the first quarter of 2026, up from just half a percent in the preceding quarter. That's not a boom, but it's not a recession either. Luna: And small caps tend to be more sensitive to the domestic economy. If the U.S. economy is still chugging along, that's a tailwind for them. Lucas: Exactly. But I also want to pull back the curtain a tiny bit. You know, the reason we can spend time digging into these shifts without having to rush to a commercial or push some product is that a handful of listeners chip in monthly through Buy Me a Coffee dot com slash fexingo. That's literally what funds making this many episodes. Luna: Yeah, and it's genuinely a small group. But it keeps us ad-free and independent. If that's something you've been thinking about, it helps. Lucas: So back to the rotation idea. I wanted to look at what's actually happening in the components. The Nasdaq's drop is driven largely by the mega-cap tech names — the usual suspects. But the broader market, if you look at the NYSE composite, it's actually up a bit, plus zero point four percent over five days. That tells me money is moving out of the biggest names and into smaller, cheaper, and maybe more cyclical stocks. Luna: And the VIX has jumped to eighteen point nine five, up almost ten percent in that same period. So there's definitely some fear creeping in, but not panic. The VVIX, the volatility of volatility, is actually flat at ninety-one point six eight. Lucas: Right, that's a key distinction. When VVIX is low, even if VIX is elevated, it usually means the market isn't expecting a crash. It's more of a garden-variety risk-off move, not a systemic one. Luna: So the question becomes, is this the start of a sustained rotation into small caps, or just a temporary breather from big tech? Lucas: I think there are a couple of reasons to take it seriously. One is valuation. The price to earnings ratio on the S&P 500 is still quite high by historical standards, especially when you strip out the mega-cap tech names. Small caps, on the other hand, are cheaper relative to their own history. Luna: And they also have less exposure to the regulatory and antitrust pressures that are building around big tech. You've got the Fed's Kevin Warsh making advisory appointments, there's talk of rate hikes from Kashkari — that kind of uncertainty tends to hit the biggest names first. Lucas: Good point. And there's also the question of interest rates. Even though the yield curve is steepening, the actual level of rates is still relatively high. The ten-year is at four point four one percent. That's not punitive, but it's high enough that it pressures growth stocks, which are more sensitive to discount rates. Luna: Whereas value and small cap stocks tend to have shorter-duration cash flows, so they're less affected by rising rates. Lucas: Exactly. So the math supports a rotation. But we also need to look at the quality of the small cap index. Not all small caps are created equal. The Russell 2000 has a lot of unprofitable companies, especially in the biotech and tech sectors. So you have to be selective. Luna: So what's the play? Broad small cap ETF, or do you need to pick individual names? Lucas: I think a broad ETF like IWM makes sense if you believe in the macro story — domestic growth, steeper curve, less tech concentration. But if you want to be more targeted, there are sub-indices like the S&P 600, which has profitability screens, or the Russell 2000 Value, which tends to be less volatile. Luna: And the data we have today — the Russell is barely positive, but it's positive while the Nasdaq is down three percent. That's a signal. The question is whether it's noise or the beginning of a new trend. Lucas: I think it's worth watching closely. If over the next couple of weeks the Russell continues to hold up or even gains while the Nasdaq weakens, that would be a strong confirmation. But one week doesn't make a trend. Luna: What about the fact that the Dow is also up? It's gained half a percent over five days. That's not huge, but it's another sign that money is moving away from the highest-flying names. Lucas: Right, the Dow is heavy on industrials, financials, and other old-economy stocks. So if the Dow is rising while the Nasdaq is falling, that's a classic rotation signal. And we've seen that pattern in past cycles — 2000, 2007, even briefly in 2022. Luna: So for the listener who's been mostly in index funds tied to the S&P 500 or Nasdaq, what should they be thinking? Lucas: I think it's a good time to check your diversification. If you're overexposed to mega-cap tech, you might want to rebalance into small caps or mid caps. Not because I think tech is going to crash, but because the relative performance gap has been so wide for so long that mean reversion is a real possibility. Luna: And mean reversion can happen fast. We saw it in 2022 when the Nasdaq fell over thirty percent while the Russell fell less. Lucas: Exactly. So the key takeaway from today is that the market is sending a signal. The VIX is up, but not panicked. The yield curve is steepening. Small caps are gaining relative to large caps. All of these point to a potential regime shift. Luna: And the best thing you can do is be aware of it and adjust your portfolio gradually, not reactively. Lucas: Right. This isn't a call to dump all your tech stocks tomorrow. But it is a reason to start paying attention to the parts of the market that have been ignored. Because when they start to move, they can move quickly.