Small caps have further to run but tilt to midcaps in H2 due to rate hike risks (with Tom Keene, Paul Sweeney)

6/3/2026 10:17:39 PM	medium term cautious up	20 days later	+1.75%	+0.87%
6/3/2026 12:22:43 AM	medium term up	20 days later	+1.75%	+1.75%
6/2/2026 11:23:33 PM	medium term up	20 days later	+2.83%	+2.83%
12/11/2025 9:01:11 PM	medium term cautious up	21 days later	-1.69%	-0.85%

Jill Carey Hall

Small caps have been underperforming for over a decade but are now benefiting from cyclical positives: they are coming out of an earnings recession and the US manufacturing recovery is taking hold. The ISM manufacturing index is the single most correlated macro indicator with the Russell 2000.

Higher oil prices also help the RUT because it has more exposure to industries that benefit from higher oil than to consumer industries hurt by it.

Jill Carey Hall

About one-third of Russell 2000 companies are unprofitable, historically elevated due to two earnings recessions and the 2021 IPO boom. However, this is starting to come down. Biotech is the highest quality it has been in 12 years.

There was an unprecedented period of low-quality outperformance within small caps over the past year (a three-standard-deviation event). This paves the way for a return to a more normal environment where higher quality stocks work in the second half.

Jill Carey Hall

In the first half we preferred small vs midcap; for the second half we tilt toward midcaps vs small caps. Both should outperform mega caps on similar profit growth, but small caps have already had a big run.

BofA economists now expect the Fed to hike three times by year-end. The Russell 2000 has more leverage and refinancing risk due to short-term/floating rate debt exposure, making it more vulnerable to higher rates.

Jill Carey Hall

M&A activity is mostly large companies buying small caps (e.g., large pharma buying small biotech). Small caps are the targets, and their valuations are less stretched than mega caps.

Small and midcaps are now trading at similar valuations.

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