The bull market is steadily moving along but now with renewed volatility. The rotation trade has picked up steam and major indices have experienced turbulence as large market movers give up ground to their smaller or more undervalued counterparts. Summer is often a tamer period for the markets with low volatility as many traders and retail investors go on vacation or are just generally less focused on their finances. For a while it looked like that would be the case this year as well. But over the past few weeks we have seen one of the most epic rotations and swings in market history. Small caps, which have been laggards for years relative to the mega-caps, have come out of the doldrums and raced almost 10% higher this month while the S&P is slightly negative. This included a 12-day span of 13% outperformance, the largest in history. This huge rotation has narrowed the S&P 500’s year-to-date lead over the Russell 2000 (small caps) from a peak of over 16% to less than 4%. And right alongside this reversal has been a shift from growth to value. Another example of why diversification matters.
In previous discussions we have written about the great run large cap growth and specifically tech have had since the Great Recession. And just a few weeks ago the ratio of Growth to Value on a total return basis hit its highest level since the dot-com bubble. Since then however, we have seen an 11% outperformance by value. The current small cap and value rotation is being led by regional banks, homebuilders, and energy companies. Regional banks for example were up nearly 20% for the month while Nvidia and semiconductors were down roughly 15% until the big rally today as the Fed kept rates unchanged. It’s important to keep in mind that swings and rotation are normal in a healthy bull market. It is not healthy to see one pocket of the market dominate forever. Also, regional banks doing well is a very good indicator that small businesses and consumers are in good shape. As we noted last month, consumer sentiment is low but that is a reflection of the impact inflation has had on the average household. People’s investment accounts and 401(k)s have been growing but at the same time the savings rate has decreased slightly over the past year. Even though the inflation rate has come down dramatically from over 9% a couple years ago to below 3% today, prices are still much higher, and many paychecks are not keeping up with the increases. Retail sales rose just 1.9% from a year ago and adjusting for inflation that is actually a decrease in spending of 1% from last year. Consumers are definitely tightening their belts.
The recent rotation out of the Magnificent 7 (Microsoft, Apple, Google, Nvidia, Amazon, Meta, and Tesla) and into other areas has contributed to what’s called “breadth thrust,” another measure of a healthy market. The stock market is a “market of stocks” after all and the more stocks that are participating (or larger breadth) and doing well, the better the overall market. There’s an indicator called the “Advance-Decline line” that measures the difference between advancing stocks and declining ones. It has just reached a new 52-week high, the highest level of the current bull market and close to the highest level in history. So long as market internals like these remain positive, we will remain optimistic about future returns.