In the current financial cycle, the bull market is a market of superlatives. The accumulation of “firsts” and “unprecedented extremes” over the past two years shows that this bull market is leaving a truly unique trail. Last Thursday, 87% of the stocks in the S&P 500 outperformed the index itself, which Goldman Sachs called “the strongest performance in the history of our dataset.” This came after six months in which the benchmark stocks managed to beat the S&P 500 over a historical semiannual period. Similarly, Strategas Research says this is by far the most positive advance-to-decline ratio among NYSE issues on a day when the S&P 500 posted a loss. That loss, just 0.8% but the biggest daily drop since April, came of course after a spongy CPI report provided a clearer line of sight to a September rate cut by the Federal Reserve. The most profound action was the reversal in the dominance of big tech over small caps, which has widened to the extreme. The Russell 2000 jumped 5.5% while the Nasdaq 100 fell more than 1%. More broadly, Renaissance Macro says the Russell 2000’s one-day rally relative to the large-cap Russell 1000 was one of the four largest since 1980. And of the three previous episodes, all occurred near a broad market low—in 1987, 2009, and 2020—rather than at a time when large-cap indices were hitting new all-time highs six months later. All of these rare or unprecedented features of last week’s action are tied to the key feature that investors have been obsessing over for months: the deep concentration of market value in a narrow group of the largest stocks. This setup is the simplest way, mathematically, for the stock market to diverge so unusually from the S&P 500. Recall that the market has gotten this way in part because the highest-quality financial stocks—those with the most attractive earnings profiles and sexiest secular momentum—are also among the most expensive and defensive in a period of macroeconomic malaise and a dearth of reliable earnings growth. A plausible but untested conventional wisdom has held that an idealized “broadening” of the market should coincide with a Fed rate cut and the resulting democratization of earnings growth. That seems a little too neat and tidy, and history is unclear about such a sudden shift in market preference. But these days, conventional wisdom is being converted into pre-defined automated trading tactics, powered by exaggerated rotation mechanisms. And so we get days like Thursday, which seem both logical and perhaps overblown. The Bull Market Is 21 Months Old Yet it’s not just the internal back-and-forth of the latest phase of this advance that has made this cycle unique. The current bull market, which dates back to October 2022, has now lasted 21 months, exactly half the median duration of all bull markets since 1877, according to Fidelity Investments. Its total gain of 57%, as measured by the S&P 500, is also almost exactly half the average since 1929. And it’s the only one (at least in the last 70 years) that began with the Federal Reserve in the middle of a tightening campaign. (This may be fitting, given that the previous bear market started even before the first rate hike in March 2022, defying decades of precedent that stocks tended to rebound during the early months of a tightening program.) For good measure, this year the S&P 500 has had the best start to a presidential election year in history. Some macroeconomic “rules” are also broken: The 2/10-year Treasury yield curve has now been inverted (with short-term yields exceeding long-term yields) for two years, the longest stretch without a recession. One can reasonably speculate why the interplay between market rhythms and macroeconomic forces has so often exceeded historical norms in recent years. A forced flash recession and a multi-week stock market crash were followed by a rapid recovery aided by massive stimulus, leaving household finances stronger at the end of the economic shock than when it began. The tendency for the largest tech platforms to dominate and perpetuate their network advantages has been a factor for a decade, allowing winning stocks to consume a greater share of capital. And, of course, the eruption of a runaway boom in AI capital investment almost as stocks bottomed and inflation peaked in late 2022 has engorged the large-cap growth segment of the market, offsetting an abundance of weakness elsewhere. It also argues for some humility in assessing the market’s next leg, given its recent tendency to break away from patterns. What we can say with certainty is that this is a bull market, and no recent extreme or anomaly can negate the wisdom of respecting a robust uptrend. It is also reasonable to observe that very strong first halves of a year tend to be followed by above-average second halves, and that the average positive year for the market (as opposed to the average of all years) sees a gain of over 20%. What runs counter to these comforting facts, at least tactically, is the fact that the historically strong first half of July is over, with seasonal inflows becoming somewhat less favorable from here on out. And while the seasonal rhythm of election years has not really been relevant so far this year, most such years experience some choppiness and weakness after mid-summer. Does the rotation have legs? Whether last week’s dramatic reversal of fortunes in favor of abject losers at the expense in part of acclaimed winners is less clear. Certainly, the kind of violent and widespread surge in most small stocks is probably not pure fluke. Such things tend to have legs at least over a matter of weeks, according to many of the technical studies floating around. As the chart below of the Russell 2000 Index versus the Nasdaq 100 shows, the rubber band has been stretched quite far, and mean-reversion forces alone could remain a tailwind for small laggards. But it also suggests that those calling for a lasting change in the market’s character have a heavy burden of proof. As noted above, the small-cap outperformance bursts most similar to last Thursday’s occurred as damaging selloffs peaked, not in a quiet bull market in anticipation of a Fed rate cut to keep the momentum going. The best kind of initial rate cut is an “optional” cut in a healthy economy that aims to slowly normalize policy to preserve and extend an expansion. Slower, shallower easing cycles are historically more bullish than faster, deeper ones. This scenario certainly remains in play. Arguably, prices are already largely priced in at this level, with the S&P 500 once again trading at 22x forward earnings. However, the market can typically maintain a full valuation when earnings are actually growing, as they are now, and the Fed is not in a tightening mode. The bottom line is that the S&P 500 is strong but a bit overbought, with sentiment turning a bit bullish and an economic deceleration of unknown magnitude underway. The elevated sentiment environment is normal for a bull market, but sometimes associated with pauses or pullbacks. (The resolute 2021 climb is a notable exception, virtually ignoring the strained sentiment readings.) It’s also fair to wonder whether narrow leadership and uneven market internals will be dealt with in a painless rotation from big to small, from growth to value, from crowded to neglected stocks, just as a Fed rate cut is fully priced in. That would seem a little too cute, and perhaps too enjoyable for a majority of investors frustrated by a divided market and a hard-to-beat S&P 500. But then again, anything can happen, as we’ve seen time and time again of late.
News Source : www.cnbc.com
Gn bussni
