In New York morning trade, we are looking at the major US stock averages trading on both sides of flat now a fresh wave of AI jitters and trade anxiety rattling investors as we kicked off the trading week and software under siege as new concerns over AI disruption and cannibalization spark a brutal re rating and beneath the service, the rotation is re-accelerating with last year's Fed easing, hitting the plumbing and also energy catching a bid.
How does all of this affect small?
In 2026 will joining me to weigh in is Timitz who is chief investment strategist for innovator Capital Management.
Tim, good morning.
Thank you so much for joining me.
So let's start out by addressing rotation given the fact that we have 175 basis points of that easing hitting the plumbing.
Do you think the S&P 600 is the real trade and for those who are not as familiar with what's happening in the small cap index, walk us through this.
Well, Remy, good morning, and, and yes, we do think this is the real deal, uh, what's what's happening in small caps, and it's a rotation that we've really seen underway since the the lows back in April of last year after the tariff tantrum.
You know, when you look at the backdrop for small caps, we think it's one that is very strong.
We talked, you talked about the Fed easing, that's a big piece of this.
But the big thing, Remy, and something that we haven't had really over the last several years. we have earnings.
You look at earnings, uh, small cap earnings are outpacing expectations by a pretty wide margin.
They're they're outpacing large caps, when we look at those expectations, and this has been the missing element for that small cap rally over the last few years.
All of the focus has been on this valuation gap, which is really important to look at that valuation gap, but in and of itself.
That's not a catalyst to drive equities higher.
You look at the backdrop this year with earnings doing really well.
Economic growth is in a good spot.
We have PMIs that are above 50%.
We have big tax cuts, tax breaks coming to consumers.
This should help continue to propel growth.
At the end of the day, small caps are a growth story, an economic growth story, and we think the backdrop is very strong there. and so you just highlighted some tailwinds there that were paying close attention to.
But of course we are awaiting Nvidia's earnings tomorrow after the closing bell.
So when it comes to big tech caps, it is up double digit percentages year over year with multiples resetting.
But is the so-called spend to defend strategy losing the market's trust right now?
Well, Remy, I think it's going to be a source of volatility all year long.
You know, part of this is you have these mega cap tech names, the hyper scales that are trading at very, very high multiples, and investors want to see what's the ROI going to look like on that.
Now, that's not something we think you're going to know this year, but we think investors are going to react and try to speculate on that all year long.
Anytime we take a step back and you look at these companies.
Like, like Meta, like Amazon, like Microsoft that are spending $100 to $200 billion a year for this AI buildout, you've got to justify that spend, and we're looking at, you know, 60% increase on those top of the index names over last year's astronomical spend.
So we need to see if the ROI is there.
I think the CEOs These companies are confident that it's going to come, but they're not, they're not certain.
OK.
I think there is some doubt, and investors are going to continue to speculate on that.
We think it will be a source of volatility.
Investors reading into earnings reports, any little tea leaf that they can possibly pick up on.
So we need to brace for volatility at the top of the index.
I think risk management is incredibly important given the moves that we've seen over the last several years.
And you do bring up an important point because so far in 2026 we've seen so many massive moves given the concerns about AI disruption, how it will eventually shake out and affect different industries.
But when it comes to software multiples, they have crashed from 35 to 20X.
So how would you actually characterize the AI disruption phase for the markets here?
Well, it's, uh, Remi, it's interesting.
It's one of the things that we've characterized in our 2026 outlook is, is really being cautious and being aware of what we refer to as the darker side of AI.
Everybody wants, wants to talk about the benefits, uh, the increase in productivity that you're going to see, the driving of economic growth, and, and we agree with all of that.
I think there's, there's a, there's clear benefits.
You'd have to be living in a hole not to see that, but we also have to think about.
The dark side, OK, and we see that dark side really playing out a couple of different ways.
One, the impact on the labor market.
Uh, do layoffs that are related to AI stay contained?
You know, over the last year or so, you look at the mass layoffs, we think about 15% of those have been AI related.
Does that kick up in a meaningful?
A way where we're replacing human capital with AI and you're seeing a big spike in the unemployment rate.
Our economy, yes, we've had a big boost from the AIAPX, but at the end of the day we're a consumer-driven economy where that drives the majority of growth, the majority of GDP, and the majority of investment gains.
And so if we don't see people Working, they can't be out there spending money, so that hampers that piece.
The other piece, Remy, that is equally as important to pay attention to is what industries are we going to see disrupted, and this can be disruption from a margin perspective.
Maybe you're not able to charge as much on the products or services that you offered before.
I think that's the compression that we've seen in software evaluations here over the last several months.
But also, are there entire industries that are going to potentially become irrelevant?
Uh, it's certainly a risk.
Now, do we think that's something that you're gonna see full bore in 2026?
No, but it's certainly something that we want to be paying attention to as we see a broader AI rollout in this economy.
So, a lot of good things to like, uh, but we also want to be risk aware in this environment and you know how we're protecting our investments, uh, not just within the AI space but across the board is really important.
Yes, so Tim, you just mentioned risk awareness.
I do want to build on that and the surge that we're seeing in terms of a dual directional ETF.
So first, for our viewers, can you explain to us what this is and why we're seeing RIAs trading both the upside and the downside?
Yeah, Remy, uh, it's, it's a great question.
So, um, if you look at the flows into, uh, dual-directional ETFs, this is a category that didn't exist pre-innovator, uh, you know, 67 months ago, but it's a category we've seen a tremendous amount of flows in from RIAs across the country and, and really at a basic level, the reason they're gravitating towards these strategies is dual-directional ETFs allow you to.
Make money when the market goes up and when it goes down.
So, uh, you know, there's been a big wave into buffered ETFs over the last year.
On the upside, a dual-directional ETF works exactly like a buffer ETF, meaning that you have 1 to 1 on a reference asset like the S&P 500 ETF as an example, up to a cap.
So right now, I'll give you one example, DDF.
This is the 15% dual directional ETF on the S&P 500, and over the course of a year, it has an upside cap of right around 9%, meaning that if the S&P 500 from now until a year, the next 12 months, if it goes up 0 to 9%, you're going to be up 0 to 9%.
If it goes up 15%, you're capped out at that 9% level.
Now, the trade-off with that cap though is.
Really where the dual directional piece comes into this is on the downside.
In addition to that upside cap, you also have what is referred to as an inverse cap of 15%, meaning that if the market goes down 0 to 15%, you're actually going to be up 0 to 15%.
So the market goes down 10%, you're up 10%.
The market goes down 15%, you're up 15%.
It's that inverse cap, and that's what's driving a lot of investors to this broad category as a way to say, hey, over the last 3 years, we've seen an annualized return on the S&P 500 of 20%.
You know, a a a 9% return on the upside this year would be a very good year, uh, on the backs of that.
But at the same time, if we see the market pull back, we see this, this, this.
Risk play out.
The disruption risk play out.
Multiple start rating and some of the hyper scales.
We have the ability to still profit in a major way with that inverse cap.
So it's a category again, we've already seen about a billion dollars coming in the last 6 to 7 months.
We think that's going to continue to grow as investors really help manage a wide range of outcomes in 2026.
Well, Tim, we will have to leave it there for today, but thank you so much for joining us and thank you so much for weighing in on a whole range of topics as well as your insights.
Great to be with you, Remy.
