Small caps' pace of outperformance will moderate through year end, says Goldman's Tim Urbanowicz

Summary

Tim Urbanowicz, head of research at Innovator, discusses the strong year-to-date performance of small caps and argues that the pace of outperformance will slow in the second half. He attributes the moderation to reduced AI infrastructure exposure after the Russell 2000 rebalance and less attractive valuations. He believes a Fed on hold (no rate hike) and continued cyclical growth will support small caps despite the slowdown.

• Small caps have had their best first half since 1991, with broad outperformance across sectors.
• 40% of the year-to-date gains in small caps were driven by AI infrastructure stocks.
• The AI infrastructure exposure in the Russell 2000 has been cut in half after the latest index rebalance, reducing a key tailwind.
• Small cap valuations are now much less attractive than at the start of the year.
• Future small cap gains depend on a cyclical growth story and falling or stable interest rates.
• The market has priced in a Fed rate hike by year-end, which Urbanowicz believes will not materialize.
• A Fed on hold would benefit small caps due to their heavy floating-rate debt burden.