Last month, at the height of the A.I. frenzy, big-cap US tech’s outperformance to domestic small-caps reached historic extremes.
The A.I.-driven surge, as manifested in the so-called “Magnificent 7,” was solely responsible for the S&P’s trek towards bull market territory in 2023, although gains have broadened a bit this month.
Ironically, the associated sentiment shift appears to have catalyzed a bid for small-caps — perhaps it’s the accidental “retail barbell,” as JPMorgan recently described small investors’ affection both for flashy gains in mega-cap tech stocks and underdog small-caps.
The Russell 2000 came into the week on track to outperform the S&P 500 by the most in 16 months for June.
You might be inclined to suggest this is good news. After all, market participants have been subjected to a never-ending cacophony of “narrow market” bear cases and associated warnings about the fragility of a rally built solely on a handful of mega-cap growth names.
However, some view the apparent panic bid for small-caps as an ominous harbinger all its own. iShares’ Russell 2000 product enjoyed its largest weekly influx since November of 2021 last week, Vanda Research data shows. It’s certainly reasonable to ask whether the abrupt shift in favor of small-caps is suggestive of risky behavior as investors chase the rally.
As the figure above shows, the epic three-month outperformance for the Nasdaq 100 that prevailed just two weeks ago has slammed into reverse.
Of course, the shift may also be a good omen. As LPL Financial’s Quincy Krosby wrote last week, “small-caps have traditionally served as a bellwether in terms of the broader economic landscape.” At a time when recession is still the consensus macro narrative, renewed enthusiasm for cyclical value could be construed as a positive development, particularly if you think the market is efficient. Markets, Krosby remarked, “tend to ‘get the news first,’ and if flows into the Russell 2000 advance, this could be a significant market signal.”
So, which is it? Ominous harbinger or sunny bellwether?
