Markets Forgot About Mid-Caps

Markets give you discounts, or they give you growth.

Very rarely does it offer a two-for-one deal offering the best of both worlds.

Today is one of those rare occurrences.

One corner of the market is now trading at a valuation we’ve only seen during major dislocations.

American mid-caps are trading at their cheapest relative valuation compared to the S&P since the 2022 bear market.

Before that, COVID, 2008, and the lead up to the dot com bubble.

Each instance had one common factor among them:

Not unlike today with AI and technology stocks.

By itself, this doesn’t mean mid-cap stocks become an automatic buy…

But it does lay the foundation for a rotational opportunity offering attractive earnings growth for a fraction of the risk.

The best part?

Mid-caps remain largely ignored.

While retail capital - and attention - continues chasing mega-cap AI and technology, the massive advantage in this opposite corner is developing almost unnoticed.

Today we’ll dig deeper into the growth, valuation, and drivers behind American mid-caps. Three of them specifically:

Starting with the most important question of all…

Not whether mid-caps are cheap.

But,

When do mid-caps start to outperform?

Capital tends to rotate where growth accumulates.

Today, that’s technology and AI, though more companies are losing their highs as these growth assumptions get questioned as too aggressive.

Tomorrow, I believe mid-caps will steal the spotlight.

According to Goldman Sachs, Morningstar, and Bank of America:

Keep in mind,

None of these mid-caps have the AI concentration, aggressive growth assumptions, or margin expectations to come from the trillion-dollar spending waves.

Whatever the case may be, sectors that show similar growth in earnings should also trade at similar valuation multiples.

That’s where the disconnect is:

This figure is a bit outdated, but the theme hasn’t changed…

The S&P 500 now trades closer to 32x earnings, while the mid-caps trade at less than 20x.

Remember, all while growing their earnings at a similar pace.

Credit risk hits harder when you’re a smaller company.

That’s why over 72% of the mid-cap sector’s price action can be timed with Bank of America’s High-Yield Spread readings.

Whenever these spike, it tends to price in a lot more default and credit risk across the economy, so it directly impacts the appetite for owning mid-cap stocks.

Right now, they show no signs of stress despite:

The reason is that these businesses are local-first, with over 70% of their revenues coming from within the United States.

That means inflation is oftentimes good for them, are free of tariffs, and AI isn’t really going to hurt them much,

This is a very tight relationship not going to lie.

Last time we had a spike in these spreads was in late 2025, where mid-caps sold off and gave investors one of the greatest buying opportunities in the asset class.

Now that we’ve spent over six months with tight spreads, I would expect a black swan event to come in soon and give us another such opportunity.

Stay tuned for my mid-caps watchlist to buy as soon as this happens.

There’s another strong economic series that works in favor of predicting the price action in these smaller businesses:

80% of the time the PMI and mid-caps move together.

The 20% of the time that they don’t is where the best opportunities show up to buy or sell.

Right now, we’re inside that 80% of normality, all coupled with an expanding Manufacturing PMI trend.

Meaning,

If we do get a sudden spike in the high-yield spreads, and a subsequent selloff in mid-caps, the case for buying this dip right away becomes stronger as long as the Manufacturing PMI’s uptrend continues to stay in place.

That’s where going back to that 80% normality pays off.

A couple of additional indicators will help you shape your view here, and even though they are less predictive or “important”, it’s worth keeping an eye on them for future reference.

My tests suggest 35% of the mid-caps price action can be explained by the yield curve.

Less powerful, but still important as it measures the rate at which the economy is heating/cooling.

Look at the two shaded periods as an example:

Right now, we’re approaching a curve shape that resembles indecision between another bear steepening and bull flattening.

That’s why I say there’s no real telling on the timing before we get the right path out of the economic data.

Though at least we have these predictors to watch out for.

CPI has a mixed influence on mid-caps, though it is mostly positive.

As mentioned before, the local-first nature of mid-caps benefit from rising prices and their ability to pass down costs to consumers.

However,

There’s a fine line between being able to pass down costs and losing market share to bigger competitors who can easily eat those costs and not affect their demand elasticity.

I suggest you read my take on the bond trade, where the inflation call option section can show this may also be a bullish outcome for mid-caps.

Truth be told,

I think the evidence in favor of bonds is also favoring these mid-caps.

However,

We are early to both trades, so I have come up with a sort of mental map to keep in mind as we move forward and await for the right catalysts and timing.

I have put together a mid-caps brief for Offside Premium members.

Part of it is having a clear timeline and trigger in mind for this thesis to start working and offering an opening to seek exposure into it.

I’ve divided the two best triggers into:

We’re close,

The PMI - for the most part - is looking very bullish for the mid-cap trade, so all we’re really missing is inflation prints coming next month, and a shift in the Fed’s language.

Remember,

The inflation call option is still present in the Hormuz trade, and the ideal buy situation is when the high-yield spreads spike to give us the ultimate opening.

Perhaps these are mutually exclusive and happen at the same time.

One can dream…

For now, stay tuned as I will relay my current mid-caps watchlist for you to pull the trigger on once we see both the confirmation and the pivot events come in.

Click here to join Offside Premium and receive your watchlist.

I believe the market is also looking for that ultimate opening where Iran and high-yield spreads mix together.

Otherwise, why would the following trade exist:

Over 2,000 put options for $560 strike June 2028 expiry have been opened.

That’s roughly 12-15% from where the MDY ETF trades today, effectively a correction.

The kind of correction that happens on macro shifts like the ultimate opening I just talked about.

More importantly,

I do not see much call option activity for this mid-cap ETF, meaning these puts are mostly hedges against an otherwise bullish equity positioning into this area.

Highly confident we’ll get that opening here soon.

In the meantime, here’s a take on inflation from Goldman Sachs, covering all the topics I mentioned today and in my bond trade analysis.

Perhaps this clears some of the timing risk around our thesis:

Until next time,

OFFSIDE RESEARCH

Against the Tape, Ahead of the Curve.