The big things you need to know: First, Friday’s weaker than expected jobs report, which was still viewed as healthy by our economists, left us feeling incrementally better about Small Cap. Second, other things that jump out in our updates this week include the stall in stock market optimism among consumers in the latest Conference Board survey, recent deterioration in our earnings yield gap model, low layoff levels in the Challenger report, the stall in Democratic sweep expectations in midterm betting markets, and the expensive valuations we continue to see in Financials, Industrials, and Utilities.

If you’d like to hear more, here’s another five minutes.

Staring with Takeaway #1 – The Silver Lining For Small Cap

Even though Small Caps have historically tended to underperform when jobs growth is cooling and outperform when that (and other cyclical indicators like ISM manufacturing or year-ahead GDP forecasts) are ramping up, the Fed outlook has seemed to matter more for Small Cap relative performance in recent years in day to day trading. Not surprisingly, Friday’s weaker than expected jobs report was followed by a surge in Russell 2000 futures that outstripped the move in S&P 500 futures, and the Russell 2000 continued to outperform the S&P 500 in early Friday trading after the open as expectations for hikes eased.

Second, valuations in Small Cap have started to look attractive again. The market cap weighted NTM P/E for the Russell 2000 recently fell below its post GFC average and also a little bit below the Iran war low achieved earlier this year. To be clear, valuations are not deeply compelling, but they have hit an interesting threshold.

Beyond the Fed, positioning/sentiment, and valuation, it’s also worth noting that Small Cap equity flows have improved slightly while Large Cap equity flows have stumbled.

Fundamentally, it’s also worth noting that despite Friday’s jobs miss, RBC Economics still sees the labor market as healthy. Typically, Small Caps outperform when jobs growth is accelerating and lag when it is cooling.

Our bottom line: Though we’re sticking with our neutral stance on Small Cap vs. Large Cap for now, Friday’s jobs report and the downshift in hike expectations has left us feeling incrementally better about Small Caps.

Moving on to Takeaway #2: What Else Jumps Out

• First, consumer clues. Last week’s Conference Board release caught some headlines as overall consumer confidence fell a little below COVID lows. Despite the slippage, we continue to be struck by the resilience of this indicator broadly. We do note, however, that stock market optimism in this survey appears to have stalled, but hasn’t broken meaningfully lower yet. Meanwhile, expectations for interest rate increases have been rising but are not quite back to past highs. There are two bits of bad news here. First, we see this as a potential sign of fatigue with the stock market among retail investors who have become more important drivers of stocks in recent years. Also, this indicator suggests to us that we haven’t quite yet hit peak fears regarding rising rates.

• Second, erosion in our earnings yield gap model. While it’s still not at a level that has typically been followed by 12-month forward declines in the S&P 500, it is worth noting that our earnings yield gap model (which compares the bottom-up earnings yield of the index using consensus NTM EPS to the 10-year Treasury yield) has fallen into a less favorable range for the stock market as bond yields have made their latest move higher. This model is now signaling a 9.3% 12-month forward return for the S&P 500, down from more than 14% previously.

• Third, layoffs lay low. In the good news camp, layoff announcements in the monthly Challenger report came in quite low, including for key industries like Tech and Industrial Goods. We are keeping a close eye on this and other related labor indicators since (as we highlighted last week) problems in the labor market over time have often been a feature of major drawdowns (those that go meaningfully beyond 10%).

• Fourth, betting markets and the midterms. After hitting a new high on 9/23/26, expectations for a Democratic sweep in Polymarket have edged lower over the past week. We think this matters for the stock market because S&P 500 has flattened out in recent months as expectations for a Democratic sweep moved up sharply. Our July analyst survey work also suggested a Democratic sweep would be a mild negative for the stock market from a policy perspective.

• And finally, stagnant sector valuations. Despite recent underperformance, key components of the broadening trade – Financials, Industrials, and Utilities – continue to look pricey on our S&P 500 sector valuation model. Utilities and Industrials have also been considered AI picks and shovels, and their pricey valuations set them apart from the Tech sector itself (which houses industries including Semis, Software, IT Services, and Hardware but not Internet). Tech itself continues to look reasonably valued after having been derisked earlier in the year. This suggests to us that the stock market is both chasing the growth trade and derisking parts of it at the same time. Utilities also stand out on our work this week for weak EPS and sales revisions trends relative to other sectors in the S&P 500. A lack of alternatives could help the growth side of large cap lead longer.

That’s all for now. Thanks for listening. And be sure to reach out with any questions.