Rotation watch

09/16/21
  • Small caps have lagged broad market since peaking in March
  • TBBK in multi-month consolidation after +300%-plus rally
  • Another rotation enough to push “forgotten” stocks out of their ranges?

Markets never stand still for long. Even when things seem slow, there are often tectonic shifts happening beneath the surface that “suddenly” alter what seemed to be a static landscape.

Last year’s rotation away from tech is a good example. As the market rebounded from the COVID sell-off, the Nasdaq 100 (NDX)—which had led the US market for so long many people probably believed it was the tech index’s birthright—gradually lost its momentum. And between November 2020 and March 2021, the small-cap Russell 2000 (RUT) transitioned from long-time laggard to leader, leaving the NDX in the dust:

Chart 1: Nasdaq 100 (NDX), S&P 500 (SPX), Russell 2000 (RUT), 10/30/20–3/16/21. US stock index comparison chart. Portrait of a rotation.

Source: Power E*TRADE (For illustrative purposes. Not a recommendation.)


This rotation peaked in March as the NDX slipped into negative territory for the year. But as we all know now, the new “status quo” was short lived. As noted in “Market navigates risks as it sets more records,” lacking other options in a market scarce on returns, investors returned to the “familiar playbook” of pursuing mega-cap tech stocks, to the extent that by early September the NDX was again on top for the year. From mid-May through yesterday, the NDX rallied nearly four times as much as the RUT, roughly 19% vs. 5%.

No one knows when, or to what degree, the next rotational move will play out, but as Morgan Stanley analysts recently noted, cyclical and small-cap stocks underperformed this summer as various factors—including the Delta variant surge, supply chain disruptions, weather-related disasters, the Chinese regulatory crackdown, and a disappointing August jobs report—conspired to reduce Q3 GDP growth forecasts. But they also cited the possibility that the fallout from these headwinds could prove to be temporary—and potentially fuel another rotation into cyclical and value stocks, with financials as a top global pick.1

If that also means reinvigorating the small-cap space, traders may have some very well-defined breakouts to look forward to, as the RUT has traded sideways for months. The following chart shows the RUT with one of its components, bank stock The Bancorp (TBBK). It outperformed the index by a wide margin during this period, although like the RUT, it’s currently trading near the middle of its consolidation:

Chart 2: The Bancorp (TBBK) and Russell 2000 (RUT), 3/17/20–9/15/21. The Bancorp (TBBK) price chart. Small-cap hiatus.

Source: Power E*TRADE (For illustrative purposes. Not a recommendation.)


Of course, the RUT could break out of its range to the downside, or simply continue to move sideways. Again, though, markets don’t stay in one place indefinitely (even if it sometimes feels that way). Trading may seem like it’s about focusing on the particulars of a specific instrument, but staying abreast of macro developments can be the difference between fighting the tide and swimming with it.

Today’s numbers include (all times ET): Weekly jobless claims (8:30 a.m.), Philadelphia Fed Manufacturing Index (8:30 a.m.), Retail Sales (8:30 a.m.), Business Inventories (10 a.m.).

 

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1 Morgan Stanley. “Next Market Rotation Could See Value Stocks on Top.” 9/13/21.

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