S&P 500's $18 Trillion Rally Is 'Broadening Out'

Matt Maley at Miller Tabak says the gauge has reached the kind of overbought condition that has been followed by declines over the past two years.

“Thus, this could be signaling that the small cap sector is due for some sort of short-term breather,” he noted. “At the very least, investors should be careful about chasing these stocks over the near-term.”

In such case, he says it will be interesting to see if there’s a reversal of the “rotation” move. Tech stocks are coming off their own overbought condition, so there’s no guarantee that they will advance during a pullback in the small cap names., he said.

The bottom line? If both tech stocks and the small caps decline at the same time, it could cause “some problems for the overall market,” he noted. The move on the Russell 2000 is bullish, but investors should be ready for a potential potential profit-taking/consolidation in the sessions ahead, according to Dan Wantrobski at Janney Montgomery Scott.

“The longer-term monthly chart on the Russell shows a better picture of its potential,” he noted. “We believe the Russell 2000 can trade back toward its all-time highs as mean reversion in relative strength highlights further bandwidth for the sector against this year’s leadership (tech/AI/Mag7).”

Wantrobski also pointed out that broader market breadth/participation has been improving since the CPI rally last week, with the NYSE cumulative A/D line now close to making new highs.

“The battle between the broader markets and 2024 leadership is set to continue over the short run in our view, as relative strength disparities between these groups show the potential for more rotation ahead,” Wantrobski said.

“This cannot be confirmed as a long-term trend/investment theme at this time. So for now, we continue to treat this as a trading opportunity (mean reversion move),” he added.

Craig Johnson at Piper Sandler says it is too early to determine whether a sustainable rotation can be maintained. More time and technical evidence are needed to confirm sustainable broadening participation that can lift the market higher is underway.

“The current (and long-awaited) broadening of equity gains is welcome, but elevated valuations will limit further market upside to low single digits overall for the remainder of the year,” said Robert Teeter at Silvercrest Asset Management.

The relative performance of the Nasdaq versus the Russell 2000 has been on a wild ride since 2020, with each besting the other by more than 40 percentage points over different one-year holding periods since the pandemic crisis, according to Nicholas Colas at DataTrek Research.

Dramatic small cap outperformance has only occurred after a tech stock crash or when retail investors created a small-cap bubble, he said.

“Neither setup is relevant now. We believe the Nasdaq will outperform the Russell by its 2003–2019 average of two points over the next year,” he noted.

As for whether the S&P 500 or Russell 2000 will outperform over the rest of the year, his view is that both will now do equally well but not at the same time due to their low correlation.

“For the moment, small caps have the better momentum because money managers cannot afford to stay as underweight as they have been forced to be over the last 18 months,” Colas said. “Once their reweighting is done, the S&P should be able to play catch up.”