Stock Rotation Surges While Iran Deal Remains Elusive
Small stocks are now leading and investors are finding plenty of names that are not wildly overbought.
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The setup I discussed on Tuesday morning played out as anticipated, with some sell-the-news action in the Magnificent Seven names, large retailers and pharmaceuticals while money rotated into smaller stocks. The DJIA was slightly negative while the Russell 2000 small cap index (IWM) gained a robust 1.85% and finished at the highs of the day.
Breadth Tells the Story
About 59% of stocks were in positive territory, but most notably, there were nearly 300 stocks at new 12-month highs while only 100 were at new 12-month lows. Just a week or so ago, those numbers were reversed as the indices hit highs on narrow strength in a small number of mega-caps. Now it is the small stocks that are leading, and investors are finding many names that are not yet wildly overbought. The setups worth watching are stocks with rising volume, breakouts from longer bases, and individual catalysts that justify the move.
The Equal Weight S&P 500 (RSP) kept pace with the cap-weighted S&P 500 (SPY), but most of the rotation was into much smaller stocks than those that make up the S&P 500. The list of stocks that jumped by more than 10% was sizable.
The Late-Cycle Concern Does Not Apply Yet
The question now is whether the smaller stocks can build on this momentum. The conventional wisdom is that when small stocks are leading, it is late in the cycle. The gulf in performance between many of the mega caps and small stocks is so wide that the rotation can run for weeks before that concern becomes operative.
The Iran Complication
What complicates matters is that the situation in Iran is still uncertain. There are strong indications that a deal is coming, but the Iranians immediately challenge any headline suggesting it is close to being finalized. If and when a final deal is made, that will be when the biggest sell-the-news danger will occur. The longer the deal takes, the more momentum the rotation can develop and the bigger the eventual reaction in either direction.
Strategy
I am staying focused on individual stock picking and am pleased with some of the movement in my smaller stocks. I am managing them tightly and will do my best to keep accounts close to highs. This is the type of environment where a sharp reversal in small stocks can occur quickly, so it is important to stay reactive and be aware of upcoming catalysts.
Have a good evening. I’ll see you tomorrow.
At the time of publication, DePorre had no positions in any securities mentioned.
