With Federal Reserve Chair Jerome Powell’s term set to wind down in 2026, investors are weighing what a shift at the top of the central bank could mean for rates, growth, and stock leadership. On Fox Business’ “Making Money,” EMJ Capital president and portfolio manager Eric Johnson argued that the coming period may favor smaller companies, calling it a moment of “generational mispricing opportunities in small-cap stocks.”
His comments arrive after years of big-cap dominance and an aggressive rate cycle that reshaped financing costs across the economy. Johnson’s case centers on the idea that small caps have been left behind, and that policy normalization could unlock value. The discussion also highlights the stakes around the Fed’s next moves and the choice of its next chair.
Policy Crossroads After An Unusual Cycle
Powell’s term as chair runs through May 2026. Markets will spend the next two years tracking not just the path of inflation and unemployment, but also the debate over continuity versus change at the Fed. The central bank raised rates at a historic pace in 2022 and 2023 to cool inflation, then slowed as price pressures eased. The policy mix—high rates, shrinking the balance sheet, and firm guidance—reset borrowing costs for households and businesses.
That shift hit smaller borrowers hardest. Many micro and small-cap companies rely more on floating-rate debt and bank lending. When benchmark rates rose, their interest expense increased faster than that of cash-rich megacaps. As a result, investors favored companies with strong balance sheets and steady cash flows.
Small-Cap Case: Valuation, Rates, and Reversion
Johnson said this period has left small caps mispriced relative to their cash flow potential. He pointed to the gap between small- and large-cap performance since 2022, arguing that the spread sets up a favorable entry point if borrowing costs ease. While not making a timing call on cuts, he framed the opportunity as cyclical, not just stock-specific.
“Generational mispricing opportunities in small-cap stocks,” Johnson said, describing the scale of the gap he sees.
Several factors support that view:
- Small-cap indexes have lagged large-cap benchmarks for multiple years amid higher rates and tight credit.
- Valuation multiples for many small-cap sectors sit at discounts to long-run averages.
- Any easing in funding costs could boost margins and refinancing prospects for smaller firms.
Historically, small caps have tended to lead during early recoveries and periods when credit loosens. If inflation continues to moderate and the Fed signals a glide path lower for rates, the setup could resemble those past cycles.
Counterpoints: Earnings, Credit Risk, and Fiscal Overhang
Skeptics note that cheap can stay cheap if earnings fail to recover. Some small companies still face margin pressure from wage costs and input prices. Bank lending standards remain tight in several sectors. If growth cools faster than inflation, smaller firms could see revenue slow before financing costs ease.
There is also uncertainty around the Fed’s balance-sheet policy. A faster or slower pace of quantitative tightening can move longer-term yields, which influence corporate borrowing. Fiscal dynamics add another layer, as high Treasury issuance may keep term premiums elevated even if the policy rate falls.
Johnson acknowledged that stock selection matters. Companies with high leverage and near-term refinancing needs face the biggest risks. He suggested focusing on businesses with pricing power, improving free cash flow, and catalysts such as cost cuts, asset sales, or market share gains.
What A Leadership Shift Could Mean
As Powell’s tenure nears its end, the White House and Senate will shape the path ahead. A reappointment would signal continuity. A new chair could shift the balance of priorities between inflation fighting, employment, and financial stability. Even subtle changes in communication style can move markets.
For investors, the message is to watch the data and the Fed’s reaction function. Inflation, wage growth, labor supply, and credit spreads will guide the policy stance more than the calendar. A slower-growth, lower-inflation mix would lift rate-cut odds and aid small caps. A stickier inflation backdrop would keep the policy rate higher for longer.
What To Watch Next
- Inflation trends: Services inflation, shelter costs, and wage growth.
- Credit conditions: Bank lending surveys, high-yield spreads, and small-business financing rates.
- Earnings revisions: Profit outlooks for small-cap sectors like industrials, software, and healthcare.
- Policy signals: Fed minutes, dot plots, and remarks on the balance sheet.
- Succession chatter: Reports on potential Fed leadership candidates.
Johnson’s call comes down to timing and discipline. If funding costs ease and earnings stabilize, small caps could close part of their multi-year gap with large caps. If inflation proves stubborn, the reset may take longer. Either way, the coming transition at the Fed—and the market’s path from here—will hinge on how fast policy can normalize without reigniting price pressures. Investors will be watching the data, the Fed’s guidance, and signs that small companies are turning the corner.
