I’ve long argued that small-cap stocks, and equal-weight strategies that encourage positioning in them, were due to make a big comeback. For too long, large-cap tech stocks have had an outsized impact on stock market performance.
That comeback hasn’t played out until this month. In the blink of an eye, small-cap stocks outperformed the S&P 500 in historic fashion in just a matter of five trading days. Mid-cap stocks also participated in the rally, and for a moment, it looked bullish.
But I’m skeptical that a major rotation is underway. We could still see a retest in which large-cap stocks, and namely the Magnificent 7, regain their leadership positions. Small-cap stocks could start to flounder again.
The other potential outcome is that market breadth could improve… but that stocks go down. In other words, small-cap stocks could fall less (and more slowly) than their large-cap peers.
That’s still okay because over time, being down less is still a positive. But my point is that even if small-cap stocks and equal-weight strategies are the right call moving forward, you’re not guaranteed to make money in the short term.
What will help provide some certainty will be other indicators: utility stocks, Treasurys, consumer staples stocks, lumber, gold and the CBOE Volatility Index (VIX).
Interpreting Potential Small-Cap Stocks Rotation
While a lot of technicians will argue that breadth – ensuring that stocks of all market cap ranges are advancing together — is critical to a bull market’s long-term trajectory, the short term is more driven by investor sentiment.
In other words, there is no reason to believe that the sudden outperformance of small-cap stocks is an indicator of stock market growth in the short term. In my own research, I have not found evidence that suggests improving breadth is a risk-on signal in the short term.
What this means is that, while it’s very possible we are seeing a rotation into more stock market breadth, there’s no guarantee this rotation is a bullish indicator. Investors will need to watch other indicators like lumber and gold to know for sure.
Regardless, I’m glad to see cracks in the armor of mega-cap strength. We are long overdue.
On the date of publication, Michael Gayed did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
On the date of publication, the responsible editor did not have (either directly or indirectly) any positions in the securities mentioned in this article.
