In the current financial cycle, there is a superlative growth market. The accumulation of “firsts ever” and “unprecedented extras” over the past two years makes a case that this bull is leaving truly unique hoofprints. Last Thursday, 87% of S&P 500 stocks outperformed the index itself, which Goldman Sachs called “the most in the history of our data set.” That came after six months in which the lowest-performing stocks in the benchmark had beaten the S&P 500 in every half-year period on record. Similarly, Strategas Research says it was by far the most positive advance-to-decline ratio among New York Stock Exchange issues on any day in which the S&P 500 posted a loss. That loss, just 0.8% but the biggest daily drop since April, certainly came as a weak CPI report opened a clearer line of sight to a Federal Reserve rate cut in September. The most profound action was in reversing the speed of the meltdown in Big Tech-vs.-small-cap dominance, which had grown to an extreme. The Russell 2000 jumped 5.5% while the Nasdaq 100 fell more than 1%. More broadly, Renaissance Macro says the one-day rally in the Russell 2000 against the large-cap Russell 1000 was one of the four largest since 1980. And of the three previous episodes, all occurred near a market low — in 1987, 2009 and 2020 – instead of half-yearly large-cap indices reaching new all-time highs. All of these rare or unprecedented features of last week’s stock relate to the key characteristic investors have been fixated on for months: the deep concentration of market value in a narrow group of the largest stocks. This setup is the easiest way, mathematically, for a stock measure to diverge so unusually from the S&P 500. Remember, the market did this way in part because the highest financial quality stocks—those with the most attractive earnings Sexier secular profile and dynamics – are also among the most expensive and defensive at a time of macro concern and lack of reliable earnings growth. Reliable but unproven conventional wisdom has held that an idealized market “expansion” should coincide with a Fed rate cut and resulting democratization of profit growth. It seems a bit too neat and tidy, and the story isn’t clear for such a sudden change in market preferences. But these days conventional wisdom turns into predetermined automated trading tactics accompanied by exaggerated spin mechanics. And so we have days like Thursday, which seem both logical and perhaps excessive. 21-Month Bull Market However, it is not just the in-and-out of the last phase of this progression that has made this cycle unique. The ongoing bull market, which dates back to October 2022, is now 21 months long, which is exactly half the average length of all bull markets since 1877, according to Fidelity Investments. Its total return of 57%, as measured by the S&P 500, is almost half the post-1929 average as well. And it’s the only one (at least in the last 70 years) that started with the Federal Reserve in the middle of a tightening campaign. (Perhaps that fits, given that the previous bear market began to reverse even before the first rate hike in March 2022, defying decades of precedent that stocks tended to rise during the opening months of a tightening program.) For good measure, this year, the S & P 500 has posted the best start to a presidential election year. Some macroeconomic “rules” are also failing: the 2/10-year Treasury yield curve has been inverted (with short-term yields exceeding long-term yields) for two years, the longest such stretch without a recession. We can reliably guess why the interplay of market rates and macro forces have so often exceeded the limits of historical rates over the past few years. A forced recession and a weeks-long market crash were met with a spring-loaded recovery aided by massive stimulus, leaving household finances stronger at the end of the economic shock than at the beginning. The tendency of the biggest tech platforms to dominate and perpetuate their network advantages has been a factor for a decade, allowing winning stocks to consume a larger share of capital. And, of course, the explosion of a runaway AI equity investment boom around the time stocks bottomed out and inflation peaked in late 2022 has engulfed the large-cap growth segment of the market, offsetting plenty of weakness somewhere else. It also argues for some humility in holding back the market’s next act, given its recent tendency to break patterns. What we can say for sure is that this is a bullish market and no recent extremes or anomalies can nullify the wisdom of following a strong uptrend. It’s also reasonable to note that very strong first halves of a year tend to be followed by above-average second halves, and that the average positive year for the market (compared to the average of all years) sees a gain of over 20%. Working against these comforting facts, at least tactically, is the fact that July’s historically strong first half is over, with seasonal inputs growing slightly less friendly from here. And while the seasonal cadence of the election year hasn’t really mattered so far this year, most such years experience some wobble and weakness after midsummer. Spinning have legs? It is less clear whether last week’s radical reversal of fortunes favors ugly losers at the partial expense of well-known winners. Of course, the kind of violent and widespread momentum that erupted from most smaller stocks is unlikely to be a genuine case. Such things tend to have some legs for at least a few weeks, according to the many technical studies making the rounds. As the below chart of the Russell 2000 relative to the Nasdaq 100 shows, the rubber band was stretched too far and only mid-reversion forces may remain a tailwind behind the minor laggards. But it also suggests that those calling for a long-term change in the character of the market face a high burden of proof. As noted above, the most similar one-day bursts of small-cap performance to last Thursday’s occurred as the large, damaging sell-off was peaking, rather than in a quiet bull market calling for rate cuts of the Fed to keep things humming. The best type of initial rate cut is an “optional” one in a healthy economy that aims to slowly normalize policy to maintain and prolong an expansion. Slower, shallower easing cycles are historically more bullish than faster, deeper ones. This scenario certainly remains in play. Perhaps something close to it is already priced in to a significant degree, with the S&P 500 again pushing 22 times forward earnings. Although the market can usually hold a full valuation when earnings are really rising, as they are now, and the Fed is not in tightening mode. Bottom line, the S&P 500 is strong, but a little overbought, with sentiment turning slightly upbeat and an economic slowdown of some unknown magnitude developing. An elevated sentiment backdrop is par for the course for a bull market, but is sometimes accompanied by pauses or pullbacks. (The climb set in 2021 is a notable exception in virtually ignoring the strained sentiment readings.) It’s also fair to question whether tight leadership and uneven market internals will be addressed in a painless rotation from large to small, from growth to value. , filled with neglected stocks, just as the Fed’s rate cut is being fully priced in. That would seem kind of cool and probably too sweet for most investors frustrated by a split market and a hard-to-beat S&P 500. Then again, anything can happen, as we’ve seen time and time again lately.
Investors bet on Fed rate cut to spur rotation from crowded to neglected stocks as bull market continues