Investors bet the Fed’s interest rate cuts will spur a bull market that continues to shift from crowded stocks to overlooked stocks | Wilnesh News
In the current financial cycle, there is an extremely strong bull market. The “first-ever” and “unprecedented extreme” build-up over the past few years shows that this bull is leaving a truly unique hoofprint. Last Thursday, 87% of stocks in the S&P 500 outperformed the index itself, which Goldman Sachs called “the most in the history of our data set.” The six months prior to that had seen the fewest stocks beat the S&P 500 in the benchmark index for any half-year period ever. Likewise, Strategas Research said this was by far the most positive advance/decline ratio among NYSE stocks on any day the S&P 500 fell. The drop was just 0.8%, but it was the biggest one-day drop since April, and certainly came after a weak CPI report opened a clearer picture for the Fed to cut interest rates in September. The most profound move is the cog-melting reversal of Big Tech versus small-cap dominance that has grown to its breaking point. The Russell 2000 rose 5.5%, while the Nasdaq 100 fell more than 1%. More broadly, Renaissance Macro said the Russell 2000’s single-day gain against the broader Russell 1000 was one of the four largest gains since 1980. point nearby. All of these rare or unprecedented features of last week’s moves are tied to a key feature that investors have been focusing on for months: a high concentration of market cap among the largest clusters of stocks. Mathematically, this allocation is the easiest way for most stocks to deviate from the S&P 500 in such an unusual way. Stocks that are attractive in terms of profile and the sexiest long-term dynamics in a period of macro instability and a lack of reliable earnings growth – are also the most expensive and defensive. The seemingly reasonable but untested conventional wisdom holds that an ideal market “expansion” should coincide with the Fed’s interest rate cuts and the resulting democratization of profit growth. This seems a little too neat, and sudden changes in market preferences are historically unclear. But today, conventional wisdom has devolved into preset automated trading strategies, influenced by exaggerated spin mechanics. So we get days like Thursday where it seems both logical and maybe a bit over the top. The Bull Market Has Lasted 21 Months But what’s unique about this cycle isn’t just the insider trading of the latest phase. The ongoing bull market began in October 2022 and has lasted 21 months, exactly half the median duration of all bull markets since 1877, according to Fidelity Investments. As measured by the S&P 500, the total gain was 57%, almost exactly half the post-1929 average. And this is the only time (at least in the past 70 years) that the Fed has initiated an austerity campaign. (Perhaps that’s fitting, since previous bear markets have started rolling even before the first rate hike in March 2022, defying decades of precedent in which stocks tend to rise in the early months of tightening programs.) S&P The 500 Index is off to its best-ever start to a presidential election year. Certain macroeconomic “rules” are also breaking down: The 2/10-year Treasury yield curve has now been inverted (short-term yields exceed long-term yields) for two years, the longest period of time without a recession. We can reasonably speculate as to why the interplay of market rhythms and macro forces has often exceeded historical norms over the past few years. The forced rapid recession and weeks-long market crash were followed by a spring-like recovery aided by massive stimulus measures, leaving household finances stronger at the end of the economic shock than at the beginning. The decade-long trend for the largest tech platforms to dominate and maintain their online dominance has been a factor, allowing winning stocks to consume a greater share of capital. Of course, almost as soon as stocks hit bottom and inflation peaked in late 2022, a runaway AI capital investment boom exploded, absorbing the large-cap growth sector of the market and making up for a lot of weakness elsewhere. Given the market’s recent tendency to break patterns, it also advocates a certain humility when it comes to standing in the way of the market’s next move. What we can say with certainty is that this is a bull market, and no recent extreme or anomaly can dispel the wisdom of respecting a strong uptrend. It’s worth noting that very strong first halves tend to be followed by above-average second halves, and the market’s average positive year (as opposed to the average for all years) has gains of over 20%. Contrary to these comforting facts, the historically strong first half of July is over, at least tactically, and seasonal input becomes less friendly from here on out. While the seasonal election year rhythms haven’t really come into play so far this year, most such years do experience some volatility and weakness after mid-summer. Does spin have legs? It’s less clear whether last week’s radical reversal of fortune favored the heavy losers at the expense of the much-lauded victors. To be sure, it’s unlikely that the kind of violent, broad-based momentum most small-cap stocks have exploded into is a pure fluke. According to multiple ongoing technical studies, this sort of thing tends to work for at least a few weeks. As the chart below of the Russell 2000 Index versus the Nasdaq 100 shows, the rubber band has been stretched so far that the power of mean reversion alone continues to propel the small laggards. But it also illustrates the heavy burden of proof faced by those calling for lasting shifts in market characteristics. As noted above, the single-day outperformances most similar to last Thursday’s for small-cap stocks occurred at the peak of a broad, damaging sell-off, rather than during a quiet bull market in anticipation of a Fed rate cut to keep momentum alive. The best way to initially cut interest rates is an “optional” rate cut in a healthy economy, designed to slowly normalize policy to maintain and expand the economic expansion. Historically, slower and shallower easing cycles have been more optimistic than fast and deep easing cycles. This is certainly still the case. Arguably, prices approaching this level are already largely priced in, with the S&P 500’s forward price-to-earnings multiple rising again by 22x. Although when earnings do grow, the market can usually maintain full valuations, as it is now, and the Fed is not in tightening mode. The bottom line is that the S&P 500 is strong but a bit overbought, sentiment has turned a bit more bullish, and the economy is slowing down to an unknown extent. Elevated sentiment is the norm in the bullish process, but is sometimes associated with pauses or pullbacks. (The resolute rally in 2021 is a notable exception, all but ignoring the overblown sentiment readings.) Questioning whether market leadership narrowness and internal imbalances can be resolved by a painless rotation from large to small, and from growth to value, is It’s also fair. To investors, this seems too cute.
