Latest / Bull Market Conversations with Fexingo: Rallies, Momentum, and Riding Market Strength / Why Cloudflare Is Falling in a Bull Market and What It Signals
Transcript
- Lucas: So the S&P 500 is at 7,394, the Dow is basically flat just under 51,000, and the Russell 2000 is up more than 3% in the last five days. That's a pretty clear rotation signal — money is moving into small caps. Luna: But not everything is participating. Cloudflare — ticker N-E-T — is down over 9% in that same window. That's a big drop for a stock that's still well off its highs. Lucas: Yeah, and that's the kind of divergence that gets my attention. The broad market is at all-time highs, the Russell is catching a bid, and yet a name like Cloudflare — which a lot of retail and institutional investors own as a core growth holding — is getting hit hard. If our conversations here help you think about moves like this differently, people have mentioned that to us. And honestly, listener support is what keeps this show ad-free and independent. If you find value in these episodes, you can toss a coffee our way at buy me a coffee dot com slash fexingo. Luna: It's a small way to keep the lights on and we really appreciate it. So back to Cloudflare — what's driving the sell-off specifically this week? Lucas: A few things. First, the macro backdrop: real yields have been creeping higher. The ten-year Treasury yield is around 4.3%, and with inflation expectations relatively stable, real yields — nominal yield minus expected inflation — are at levels we haven't seen since late 2023. That's a headwind for any asset with long-duration cash flows, which is basically every high-growth tech stock. Luna: Right, because Cloudflare's value is mostly in future earnings. Higher real yields discount those future dollars more heavily. Lucas: Exactly. And then there's the company-specific element. Cloudflare has been investing heavily in its network — building out data centers, rolling out its Zero Trust platform, pushing into the consumer VPN market. That's capital intensive. Their free cash flow is still negative on a trailing basis. So in an environment where the market is rewarding profitability and near-term earnings, a company spending aggressively to capture market share gets penalized. Luna: But isn't that the same story that worked in 2020 and 2021? Spend to grow, and the market rewards you with a higher multiple? Lucas: It is, and that's the tension. The difference is the cost of capital. In 2020, the Fed funds rate was near zero. Today it's 3.62%. Even though it's come down from the peak, it's still restrictive. So the hurdle rate for growth investments is much higher. Cloudflare needs to generate a return on that capital that exceeds the cost — and the market is skeptical right now. Luna: And we saw that reflected in their most recent earnings. Revenue growth decelerated to around 28% year-over-year, which is still impressive, but down from 32% the quarter before. And guidance was a bit soft. Lucas: Right. They guided for revenue of about $430 million in the current quarter, which was slightly below the consensus estimate. And their large customer segment — accounts spending more than $100,000 annually — grew 23% year-over-year, which is good, but it's a deceleration from 30% plus. That's where a lot of the market's concern is. Luna: So the sell-off makes sense on a fundamental level. But does it signal something broader for growth stocks, or is this Cloudflare-specific? Lucas: I think it's both. Look at the growth ETF — VUG — which is down about 0.9% over the last five days. Not a crash, but a clear underperformance relative to the Russell. And IWF, the Russell 1000 Growth ETF, is also down. So there's a rotation happening. But Cloudflare is an extreme case because its valuation is still elevated — it trades at around 12 times forward sales. When the rotation intensifies, the stocks with the highest multiples get hit hardest. Luna: And yet the Russell 2000 is up 3.1%. That's a huge weekly gain. What's driving that? Lucas: A few factors. One, the Fed held rates steady at the last meeting, and the market is pricing in a cut later this year. That's positive for small caps because they're more sensitive to borrowing costs. Two, small caps are generally more domestically focused, so they're less exposed to trade tensions or global slowdown fears. Three, valuations in the Russell are much more reasonable than in the large-cap growth space. So money is rotating out of expensive growth and into cheaper, rate-sensitive small caps. Luna: So for an investor holding Cloudflare right now, what's the right move? Do you ride it out, or take the signal and move into small caps? Lucas: That depends on your time horizon and conviction. Cloudflare has a strong business — their network is massive, they have a sticky customer base, and they're expanding into higher-margin areas like security and edge computing. The long-term thesis is intact. But the near-term headwinds are real. I wouldn't be surprised if the stock drifts lower until the next earnings report shows a reacceleration in growth or a path to positive free cash flow. Luna: And the small-cap rally — do you think it has legs? Lucas: I do, but with a caveat. The Russell 2000 is still down about 5% from its all-time high in 2021. So it's not like it's breaking out into new territory. It's catching up. If rate cuts materialize in the second half of 2026, small caps could continue to outperform. But if inflation re-accelerates and the Fed has to pause, that rotation could reverse quickly. So it's a bet on the macro outlook. Luna: Speaking of macro, the GDP data we saw — real GDP growth annualized at 1.6% as of the first quarter. That's not red hot, but it's a pickup from 0.5% the quarter before. So the economy is growing, but slowly. Lucas: Exactly. That's the sweet spot for a rotation trade — not strong enough to fuel a broad growth rally, but not weak enough to trigger a recession panic. Moderate growth with the potential for rate cuts is the ideal environment for value and small caps to lead. Luna: But then why is gold dropping? It hit a six-month low this week, even with inflation fears still around. Lucas: Gold is interesting. It's been falling because real yields are rising. Gold doesn't pay a yield, so when bonds offer a higher real return, gold becomes less attractive. Also, the dollar has been relatively strong. So even though there's inflation anxiety, the opportunity cost of holding gold has gone up. Luna: So the same real yield dynamic that's hurting Cloudflare is also hurting gold. That's a neat connection. Lucas: Exactly. It's all about the discount rate. Higher real yields compress the present value of any asset with distant or uncertain cash flows — or no cash flows at all, in gold's case. Luna: Let's bring it back to Cloudflare. What would you watch for to signal that the sell-off is over? Lucas: First, a stabilization in the ten-year yield. If real yields stop climbing, the pressure on long-duration stocks eases. Second, Cloudflare's own execution — any news on large enterprise deals, partnerships, or an acceleration in customer additions. Third, their next earnings call. If they can show that the investment cycle is starting to pay off in terms of revenue growth or margin improvement, the stock could recover quickly. Luna: And for the broader market, are you watching anything specific? Lucas: I'm watching the Russell 2000 versus the S&P 500 ratio. If that continues to rise, it confirms the rotation is real. Also, the VIX is relatively low around 13, which suggests complacency. A spike in volatility could disrupt the rotation and send investors back to large caps for safety. Luna: So the bull market is still intact, but the composition is shifting. Lucas: Exactly. It's not a bull market in growth stocks anymore. It's a bull market in value, small caps, and cyclicals. And that's a healthy development for the long term — it broadens participation and reduces the risk of a crash concentrated in a few mega-cap names. Luna: Alright, we'll keep tracking Cloudflare and the rotation. Thanks Lucas. Lucas: Thanks Luna. As always, we'll see where the market takes us next week.