Stock Pickers Might Just Finally See Small Caps in Play Again
But investors have been teased by rotational action before, so keep a close watch on the price action.
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The primary market theme for nearly two years has been narrow strength, with big-cap artificial intelligence-related stocks leading. The "Magnificent Seven" names and semiconductor stocks have been driving the senior indexes higher and hiding broad weakness in the rest of the market. What has made it even worse is that most financial media never addresses the issue.
The easiest way to see what has occurred is to compare the S&P 500 index, which is capitalization-weighted, against the S&P 500 Equal Weight exchange-traded fund RSP, where each stock, regardless of size, is given the same weight. Since August 2022, the equal-weight ETF has been up about 8%, while the S&P 500 has been up more than 25%.
The outperformance is even more stark when we look at the Russell 2000 IWM, microcaps, and various sectors like biotechnology. If you have focused on picking quality stocks, you have likely underperformed against the "Magnificent Seven," because fundamentals do not matter much.
There has been increased speculation recently that smaller stocks are finally in position to start closing the gap with the AI giants. There was rotational action on Monday, with the Nasdaq 100 QQQ and leaders like Nvidia NVDA dropping, while small caps and equal-weight indexes exhibited relative strength.
One of the theories for better action in smaller stocks is that the group tends to be more interest-rate sensitive, because they carry more debt than something like Apple AAPL, which has none, and lower rates will provide a tailwind. We have been hearing for years that small caps would eventually outperform, but they have been unable to provide sustained movement for longer than a few weeks.
We now have a couple of days of action where concerns about the AI giants and chip stocks have grown, while the Dow Jones and equal-weight indexes have gained traction. Will this continue as we head into the second-quarter earnings season in a few weeks?
We have been teased by rotational action many times, but investors keep returning to the Magnificent Seven names after a short period of doubt. All we can do is watch the price action.
Rotational action of this sort favors stock pickers who can find solid stocks with developing charts. Simply piling into the same big-cap names has been the best approach to the market for several years, but the potential for a shift is in the air.
At the time of publication, DePorre had no position in security mentioned.
