The Rotation Continues. One Sector That Has Helped Fuel It…

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Weekly Market Outlook

By Donn Goodman

MarketGauge Pro

July 31, 2024

Welcome back readers. Happy to have you. Whew what a week!

If you were sleeping all week and did not witness the daily gyrations of the markets, you would awake at the end of the week to see that most of the markets went nowhere. Except small cap stocks (IWM). Here is a recap of each day and the week:

Not surprising that small cap stocks represented by the Russell 2000 index (the smallest 2,000 market cap stocks in the Russell universe) was the standout winner along with the Dow Jones Industrial Average (DIA) and the big value mega-cap stocks that make up that index. The DIA is comprised of 30 stocks that include some of America’s largest financial companies and that gives the Dow much more of a “value tilt”.

Nor surprisingly (as we have recently covered in previous Market Outlooks), the rotation has provided a shift to value stocks for the week as the VTV (Vanguard Value ETF) was up 1.11% for the week and VUG (Vanguard Growth ETF) was down -2.54%. For five trading days this is a significant tilt towards value with a 3.65% differential. Much of the shift came from selling out of technology stocks. See the heat map below:

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You will notice that the writer above pointed out that the money was rotating from tech stocks to small cap and health care stocks.

Also, in the outlook last week, we pointed out that it had been more than a year since the S&P 500 had a one-day drop of 2% or more. Not surprisingly, we finally broke that streak as the S&P 500 had its worst one day decline in more than a year. See chart below:

Streak snapped. The streak of days without a 2% drop in the S&P 500 has ended after 356 sessions.

Broadening out.

We have suggested, both in Mish’s Daily and here in the weekly Market Outlook, that it was a few very large cap stocks that have been fueling this year’s rally in stocks. The S&P 500’s return for the first half of the year has been mainly driven by less than 10 mega cap stocks with Nvidia leading the way. This is how the S&P 500 (SPY) works as it is a market cap weighted index. This past week saw a shift (another rotation) as we are now beginning to experience momentum picking up in the equal-weighted S&P 500 index (RSP). See the example below:

Even though the S&P 500 was down on the week, the S&P 500 had more advancing than declining issues. This is a positive development and real evidence that more (potentially undervalued stocks) stocks are beginning to enter a positive period of rewarding investors. See chart below:

The Rotation Continues.

We shared details of this rotation in our commentary last week. Also, we have been pounding the table on the merit of small cap stocks over the past few weeks. If you have not yet reviewed the Market Outlooks from July 15 & 22, you may use the link below to access both articles.

The S&P 500 (cap weighted index) declines, but the Dow Jones closes on another weekly high. See chart below:

The small cap stock momentum continues.

As we have elaborated in-depth in our previous Market Outlooks, small cap and value oriented (finance and health care) stocks have lagged the narrowly-driven, mostly tech influenced markets for most of 2024. On a number of occasions, we suggested that we are either going to see a “catch-up” or a breakdown.

The last 12 trading days have seen a thrust higher for small cap stocks while many of the largest cap, especially technology related, have sold off. See chart below:

Additional proof of the small cap “melt up”

Here are some additional examples of the progress made in small cap stocks. The small cap index (IWM) is beginning to compete against the bigger cap indices of the S&P 500 and the tech heavy NASDAQ (QQQ). See examples below:

Is it too late to buy this asset class?

Given that small cap stocks (as represented by the IWM Index) are up over 10% in one month, investors are wondering “have I missed it? Will this asset class continue its forward progress and momentum at the breakneck speed as it has?

We do not know. But in comparing against other historical movements when small cap stocks come back in favor, the asset class may have plenty of room to run.

Then there are several well-known analysts like Tom Lee of Fundstrat, who has been calling for huge returns in small cap stocks before year-end. I found it humorous when I tripped upon an illustration (below) of sarcasm by the writer in describing investors’ reluctance to purchase something that has gone up double digits so quickly. One only need be reminded of technology stocks from October 2023 to May of 2024. See chart below:

Are small cap stocks still cheap?

That is the question that analysts on Wall Street are asking. We found the narrative and charts that follow supportive of the idea of continuing to invest in small cap stocks.

“Russell 2000 index valuations. On an absolute basis they are not cheap after this recent rally. But small caps remain cheap vs. large caps, trading at a 25% discount to history. Based on relative P/E of 0.74% vs. the historical average of 1.0x”

Click the links below to continue reading about:

- One sector that is very attractive
- Positive expectations from the Fed
- Election year seasonality
- The Big View bullets
- Keith’s weekly market analysis videos
- And more