Much has been written over the last few months about the narrowness of the market (poor breadth). The S&P 500 is up 12%+ year to date but there have been relatively few outperformers; a handful of ‘AI’ related stocks have soared while the remaining stocks in the S&P are flat on the year. This market action is causing some extreme readings with a record low percentage of stocks that has beaten the S&P over the last 3 months, and lowest for a calendar year, so far.
Source: NDR, as of 5/31/23
Sure, this could be a major warning, but we believe this is just market rotation and another rotation should occur in the near future. Historically, the data is on our side in this thinking, and tremendous opportunities are presenting themselves.
One such opportunity is in small cap stocks. When leadership has been this narrow in the past, small caps outperform large caps 80% of the time over the next 126 days and 100% of the time over the next 252 days. That’s a pretty good track record.
Source: NDR, as of 5/31/23
And if we look at this data slightly differently, the return numbers for small caps are staggeringly high. The chart below compares the distance to a 2 year high between the S&P 500 and the Russell 2000. The S&P 500 is about 11% from a new high and the Russell 2000 is about 27% from a new high. That spread is 16% or so, and one of the largest differences on record. The sample size is small at only 2% of observations below 15% but in that zone the annualized forward returns for the Russell 2000 is 115%! Extreme moves create extreme opportunities indeed.
Source: NDR, as of 5/31/23
Sean Dillon, CMT, CFTe
SVP, Investment Strategy
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