Follow those small cap stocks; not the overvalued mega-caps

 

With all of the talk about the AI revolution and the Mag 7 over the last year, many investors have missed a really strong investment story - the rise of small-cap stocks. 

There has been a strong move in 2026, but more importantly, there is strong outperformance versus the megacaps. The market is signaling it wants to rotate out overvalued large caps and start putting money to work in smaller caps. Whether the story is about extreme overvaluation or opportunities in smaller, riskier names, the result is an opportunity that we have not seen for some time. There has been the view that the small-cap premium is dead, but there seems to be new life in these names that requires a second look.

Gun violence - the solution is following the research

Finished reading Unforgiving Places: The Unexpected Origins of America's Gun Violence by Jes Ludwig of the University of Chicago and I am once again awed by the power of good economic research. I may have had some biases before starting the book, but I had an open mind to learn about one of the worst problems in America. 

Ludwig also presents his case and evidence without any political bias. He wants to get to the heart of the issue, and, as with many economic problems, the obvious is not always right. Most of our views on many topics are, at best, only partially correct and do not serve as the only answer. Ludwig presents all sides of the argument about why there is gun violence and what possible solutions there are, but the main driver is behavioral economics. Gun violence is not about rationality but often irrational or, as Kahneman says, system 1 reactionary thinking. You put guns in the hands of people that have different reactions to situations not based on rational but on react, fight or flight thinking, and there will be a problem with tragic results. He makes a strong argument that many current models cannot explain why two neighborhoods that are adjacent and have similar demographics can have very different gun violence statistics. The only explanation is behavioral and social interaction between individuals. The poverty argument cannot explain gun violence - there are too many contradictory facts, and the idea of "bad people" does not explain the majority of violence, nor can using jails be the solution. 

For something inherently political, this book is well-written, thoughtful, and shows the power of good research that is able to separate common opinions from real facts. 

The end of forward guidance - Good, let's use rules

 

Recent comments from Fed Chairman Warsh suggest that he is not in favor of the current forms of forward guidance. No dot plots, or perhaps not in the current form. The Fed has proven to be a poor forecaster, so the guidance may not be helping the market. It does not make sense for Fed governors and presidents to give speeches on their views of the economy when most are wrong. Let’s not have the market hanging on guidance that may be wrong. 

I have always been in favor of having a more rules-based approach that provided clarity on the general direction of policy. Can there be deviations from the rules? Yes, but there have to be good reasons that are infrequent. Of course, many governors and presidents like to give speeches, so there has to be a change in the messages to the market.

Gold overtakes Treasuries as central bank reserves

 

From work done by the ECB, gold has now overtaken US Treasuries as the largest reserve asset for central banks. This is driven by the strong price appreciation of gold over the last year, even with the recent declines. US Treasuries have seen yields rise, reducing the value of the asset. This is not surprising, given the strong buying by central banks, especially over the last four years, amid rising inflation. Still, it suggests that central banks have less confidence in government debt as a safe asset.

Safety is relative, and from the perspective of central banks, it makes sense to hold an asset that is likely to preserve its value during periods of higher inflation. Is the inflation-gold link strong? Not really, but it does seem to be a better inflation hedge than bonds when an inflation shock is expected. Gold can earn some yield if it is leased, but generally there is no yield, whereas bonds may earn a positive real yield.  

Central banks are telling us they lack confidence in their ability to control inflation globally.