Last week we at Cornerstone told you about the “summer of small-cap stocks” that’s unfolding. Since then, there have been more notable developments and data that give us a better understanding of the underlying forces supporting this breakout.
As of this writing, the Russell 2000*, which is full of small-cap stocks, is up 9.7% (using the exchange-traded fund iShares Russell 2000 ETF (IWM) as a proxy) while the S&P 500#, which holds much larger companies, is up only 1.7% (using the SPDR S&P 500 ETF Trust (SPY) as a proxy).
Initially we thought the small-cap rally would be at least partially funded from the more than $6 trillion of cash on the sidelines. However, newer data shows it’s mostly being funded via a rotation out of large-cap stocks.
Evidence of this action includes last Tuesday’s results for Tesla, Inc. (TSLA) and Google parent company Alphabet Inc. (GOOG)^. They both beat revenue and earnings expectations but didn’t do well in after-hours trading:
Why are large-cap stocks experiencing weakness as their earnings and outlooks have been solid? From a macro level, we think this is mostly a consolidation after the sizable gains posted this year. After all, the Nasdaq 100 is still up 17% in 2024, even with this rotation underway.
Moving back to smaller stocks, we're seeing technical confirmation of this breakout. Mark Newton from research firm Fundstrat highlighted a handful of items showing small-cap strength, including an expected move to $244 per share for IWM, which is near its all-time high:
This suggests the small-cap run could last into late August or early September, which aligns with the general expectation we outlined last week (i.e., smaller stocks are bullish as a near-term investment idea).
To be clear, we remain constructive on the S&P 500 for the for the totality of the year. Still, it’s important to recognize and understand the compelling nature of this unique market action.
We’ve mentioned the rising probability of the Federal Reserve cutting interest rates soon. Keep in mind that the Fed case for cuts is premised on the idea that inflation is falling like a rock.
That notion was further confirmed last Friday with a minimal 0.1% month-over-month increase in the June Personal Consumption Expenditures index. It was in line with expectations and continues inflation’s downward trend:
Perhaps more importantly, high real rates (the federal funds rate versus inflation) have begun to create cracks in durable goods, auto sales, and housing. That said, Fed cuts would be supportive of recovery in those areas:
Interestingly, existing home sales data for June showed a significant kink in our economic armor, coming in at 3.89 million versus a consensus expectation of 3.99 million:
It’s the fifth consecutive month existing home sales have fallen despite flat mortgage rates. In fact, over 35% of Nashville homes for sale saw price cuts in June:
Even castles are seeing price drops.
Kidding aside, this home sales situation furthers the argument for the Fed to cut rates sooner rather than later. Some economists are now even brave enough to publicly state that the Fed is already late to cutting rates.
A Massive “Catch Up” Trade Is Underway
Let’s dig further into money flows to find more support for the macro and technical data discussed thus far – specifically the activity from “big money” professional investors. Looking at SPY, it reflects a bull market gaining in value, with the recent dip looking like a normal bump in the road on the way up:
But is that really what’s happening? We think not. We think a massive “catch up” trade is underway.
The data from our friends at MAPsignals is like a set of X-ray glasses for the market. It allows us to see below the surface to derive deeper understanding.
The first thing to note is the SPY drop wasn't from measurable selling. In the chart below, the green bars represent unusually large buying, and the red bars represent selling. There wasn’t huge selling at all. In fact, there was buying on a level not seen since mid-December:
So, what's going on?
Well, IWM shot to new highs:
Looking underneath the surface, we can see something most others cannot – unusually large buying clearly shows money flowing into small-cap stocks in a historic way:
From July 1-16 alone, small-cap stocks added $326 billion in value with virtually no selling.
SPY’s dip was sizeable. But the recent drop in value for the technology-heavy Nasdaq 100+ (using the Invesco QQQ Trust (QQQ) as a proxy) was even more pronounced:
Notice there's hardly any red, which means selling hasn’t broken down to technical lows.
Thus, if large-cap tech is under pressure and small-cap stocks are flying high, the data clearly shows this is a rotation and not a cash infusion. Even with strong fundamentals, right now large-cap tech is getting hit with profit taking and that capital is rolling into smaller stocks.
So, it’s not surprising that tech slipped from the top spot in MAPsignals’ sector rankings:
Financials stocks, many of which are smaller in size, exploded higher. Even the most unloved sector – real estate – shot up from the bottom to the middle of the pack (it hasn’t been this high in a long time).
All this data confirms a massive “catch up” trade is underway. Money is gushing from long held favorites to previously unloved areas of the market and smaller stocks.
This is indicative of the old paradigm of finding safety quietly shifting over the years. “Safety” in today's economic environment has clearly been large, cash-hoarding tech stocks. It is glaringly obvious money was hiding in plain sight in the biggest stocks.
Suddenly, money is chasing everything other than “safety” in the near term.
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* The Russell 2000 Index is a stock market index measuring the performance of 2,000 smaller companies included in the Russell 3000 Index and is widely regarded as a bellwether of the U.S. economy.
# The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market.
^ GOOG is owned in Cornerstone client accounts.
+ The Nasdaq 100 Index is a collection of the 100 largest, most actively traded non-financial companies listed on the Nasdaq stock exchange.
Securities sold through CoreCap Investments, LLC. Advisory services offered by CoreCap Advisors, LLC. Cornerstone Financial and CoreCap are separate and unaffiliated entities.