In the current financial cycle, there’s a bull market in superlatives. The pileup of “first time ever” and “unprecedented extremes” over the past couple of years amounts to a case that this bull is leaving truly unique hoofprints. Last Thursday, 87% of S & P 500 stocks outperformed the index itself, which Goldman Sachs called “the most in the history of our data set.” This came after six months in which the fewest stocks in the benchmark had managed to beat the S & P 500 of any half-year period on record. Similarly, Strategas Research says it was by far the most positive advance-decline ratio among New York Stock Exchange issues in any day in which the S & P 500 posted a loss. That loss, a mere 0.8% yet the biggest daily drop since April, came of course after a squishy CPI report opened a clearer line of sight to a Federal Reserve rate cut in September. The most profound action was in the gear-melting reversal in the Big Tech-vs.-small-cap domination, which had grown torqued to an extreme. The Russell 2000 jumped 5.5% while the Nasdaq 100 fell more than 1%. More broadly, Renaissance Macro says the one-day surge in the Russell 2000 against the large-cap Russell 1000 was one of the four largest since 1980. And of the three prior episodes, all occurred near a climactic broad-market low – in 1987, 2009 and 2020 – rather than with the big-cap indexes half a year into clocking fresh all-time highs. All of these rare or unprecedented features of last week’s action tie back to the key characteristic investors have been fixated on for months: the profound concentration of market value in a tight cluster of the largest stocks. This configuration is the easiest way, mathematically, for the mass of stocks to diverge in such unusual fashion from the S & P 500. Recall, the market got this way in part because the highest financial-quality stocks – those with the most attractive earnings profile and sexiest secular dynamics – are also among the most expensive and most defensive in a time of macro unease and scarcity of reliable earnings growth. Plausible but untested conventional wisdom has held that an idealized “broadening out” of the market should coincide with a Fed rate cut and resulting democratization of profit growth. It seems a bit too neat and tidy, and history isn’t clear on such a sudden change in market preference. But these days conventional wisdom gets converted into preset automated trading tactics juiced by exaggerated rotational mechanics. And so we get days like Thursday, which seem both logical and possibly overdone. Bull market 21 months old Still, it’s not merely the internal to-and-from of the latest phase of this advance that has made this cycle unique. The ongoing bull market, which dates to October 2022, is now 21 months old, which is exactly half the median length of all bull markets since 1877, according to Fidelity Investments. Its total gain of 57%, measured by the S & P 500, is almost exactly half the post-1929 average too. And it’s the only (at least in the past 70 years) to have started with the Federal Reserve in the middle of a tightening campaign. (Perhaps this fits, given that the preceding bear market got rolling even before the first rate hike in March 2022, defying decades of precedent under which stocks tended to rally through the initial months of a tightening program.) For good measure, this year the S & P 500 has posted the best-ever start to a presidential election year. Certain macroeconomic “rules” are also failing: The 2/10-year Treasury yield curve has now been inverted (with short yields exceeding long-term yields) for two years, the longest such stretch without a recession arriving. We can plausibly surmise why the interplay of market rhythms and macro forces have so often exceeded the bounds of historical norms over the past few years. A forced flash recession and multi-week market crash was met with a spring-loaded recovery helped by massive stimulus, leaving household finances stronger at the end of the economic shock than at the start. The tendency of the largest tech platforms to dominate and perpetuate their network advantages has been a factor for a decade, allowing the winning stocks to consume a greater share of capital. And, of course, the eruption of a runaway AI capital-investment boom almost the moment stocks bottomed and inflation peaked in late 2022 has engorged the big-cap growth segment of the market, compensating for an abundance of weakness elsewhere. It also argues for some humility in handicapping the market’s next act, given its recent tendency for breaking patterns. What we can say for sure is that this is a bull market, and no recent extremes or anomalies can repeal the wisdom of respecting a sturdy uptrend. It’s also sensible 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 above 20%. Working against these comforting facts, at least tactically, is the fact that the historically strong first half of July has ended, with seasonal inputs growing a bit less friendly from here. And while the seasonal election-year cadence hasn’t really been relevant so far this year, most such years do undergo some churn and weakness after midsummer. Rotation have legs? Whether last week’s radical reversal of fortune in favor of the abject losers at the partial expense of the acclaimed winners is less clear. For sure, the kind of violent, broad momentum burst by most smaller stocks is unlikely to be a pure fluke. Such things tend to have some legs at least over a matter of weeks, according to multiple technical studies making the rounds. As the chart below of the Russell 2000 relative to the Nasdaq 100 shows, the rubber band was stretched pretty far, and the forces of mean-reversion alone could remain a tailwind behind the little laggards. But it also suggests those calling for a lasting shift in market character face a high burden of proof. As noted above, the most similar one-day outbreaks of small-cap outperformance to last Thursday’s happened as broad, damaging selloffs were culminating, and not in a calm bull market looking toward a Fed rate cut to keep things humming. The best type of initial rate cut is an “optional” one in a healthy economy that is aimed at normalizing policy slowly to preserve and extend an expansion. Slower and shallower easing cycles historically are more bullish than rapid and deep ones. This scenario certainly remains in play. Arguably something close to it is already priced in to a considerable degree, with the S & P 500 pushing 22-times forward earnings again. Though the market can typically hold a full valuation when earnings are indeed growing, as they are now, and the Fed is not in tightening mode. Bottom line, the S & P 500 is strong but a bit overbought, with sentiment getting a bit lopsidedly optimistic and an economic deceleration of unknown extent underway. The elevated sentiment backdrop is par for the course for a bull market, but sometimes associated with pauses or pullbacks. (The resolute ascent in 2021 is a notable exception in virtually ignoring stretched sentiment readings.) It’s fair, too, to question whether the narrow leadership and uneven internals of the market will be addressed in a painless rotation from large to small, growth to value, crowded to neglected stocks, just as a Fed rate cut is getting fully priced in. This would seem somewhat too cute, and perhaps too pleasing to a majority of investors frustrated by a split market and hard-to-beat S & P 500. Then again, anything can happen, as we’ve seen over and over again lately.
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