It’s Friday! But some investors may not be so stoked based on how markets have looked this week.

While Nvidia and Tesla moved into the green, Apple, Microsoft, and Amazon tumbled Thursday, dragging the S&P 500 with them.

All three benchmark indexes finished the day lower. The small-cap Russell 2000 also declined for its second session in a row.

Today, we’re unpacking how far the small-cap rally can go, Netflix’s earnings beat, and how tariffs could impact inflation.

A short-lived upswing

Small-cap stocks have been the big surprise in markets this month, fueled by a combination of rate cut expectations and rising odds for a second Trump presidency. 

That said, the group’s blistering rally has fallen off as abruptly as it began.

From July 1 to July 16, the S&P 600 small-cap index recorded a 10.2% gain.

In the last two days, however, the index fell about 2%.

While the market’s strength does seem to be broadening beyond mega-cap tech names, that does not mean small-caps will keep marching higher.

To be clear, the jump in small-cap valuations made sense for several reasons tied to hopes for easing monetary policy. 

What’s harder to explain, though, is why Big Tech moved so sharply in the opposite direction. 

Generally, the broadening of a bull market means there are more winners, yet it doesn’t necessitate that existing winners start losing. That makes me think this performance gap isn’t likely to last.

Big and dominant businesses — like Amazon, Nvidia, Microsoft, and other Magnificent Seven names — are favored among investors for a reason. They offer more attractive, long-term upside than their smaller counterparts. 

Forward earnings tell the tale. 

Data from Yardeni Research showed the S&P 500 large-cap companies aggregate forward earnings have hit record after record this year.

Meanwhile, the same measure for S&P 600 small-cap names still hasn’t returned to 2022 levels. 

Similarly, small-caps’ forward revenues have effectively plateaued the last several years, while large-caps continue to breach their own highs.

“Interest-rate cuts should help boost forward profit margins, but we doubt a few 25bps cuts to the federal funds rate will improve [small-caps] bottom lines significantly,” strategists at Yardeni Research told clients this week.

“The problem might be that the most successful [small-cap] companies get acquired quickly these days before they can significantly boost the earnings/revenues/margins of [small-cap] stock price indexes.”

Zooming out supports this too.

The S&P 500 has more than doubled the performance of the small-cap Russell 2000 over the last five years, at 86% versus 42%, respectively.

The tech-heavy S&P 500 Information Technology index has trounced both with a more than 200% gain since 2019.

With little apparent fatigue so far on the artificial intelligence play, returns here should leave small-caps in the dust, as they have for years.

So it’s not that small-caps will start crashing.

There’s simply not enough recent history or forward guidance to suggest the current surge can last much longer.

Comments or feedback? Hit reply to this email or let me know on X @philrosenn.

*At a glance:

Elsewhere:

📺️Netflix earnings beat estimates. The company said its advertising-supported memberships ballooned 34% during the second quarter compared to the same time a year ago. Paid memberships, too, climbed 16.5% annually to hit 278 million. The stock dipped slightly lower in after-hours trading. (CNBC)

🎙️ChicagoFed President Austan Goolsbee sounded off in a new interview Thursday, signaling that the central bank is getting closer to cutting rates. If officials wait to long, he said the economy could enter a recession. Goolsbee said the Fed is currently on the “golden path” to getting inflation cooler without a full downturn. (Yahoo Finance)

📊SF Fed President Daly said inflation isn’t cool enough. Contrary to her colleague in Chicago, Mary Daly cautioned that the economy doesn’t quite have price stability. “We’ve had some really good incoming data, but even with the incoming data on inflation being positive and good data after earlier this year, we’re not there yet.” (Reuters)

🇺🇸 Tariffs could push inflation higher. And that would change the calculus on Fed rate cuts. Betting markets expect Trump to win the White House, and he’s said that tariffs will indeed be part of his economic plan. Analysts say that this will likely translate to a shallower-than-expected path of rate cuts, given the potential for an inflation rebound. (MarketWatch)

Rapid-fire:

Podcast:

I interview investor Anthony Pompliano on the Trump trade, small-cap stocks, and why Trump is considering JPMorgan CEO Jamie Dimon for Treasury Secretary:

Last thing:

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