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“Dow, S&P 500 close at new record highs” – Every Major Financial Publication, June 2, 2014
You wouldn’t know it after reading any major financial publication yesterday, but the average U.S. stock is down over -1% thus far in 2014. But how can that be if we’re being told almost daily that the Dow and S&P 500 are hitting new all-time highs? The answer is likely to surprise you, especially if you have been focused solely on the large cap space.
There is a massive divergence going on between the haves and have-nots, or the largest capitalization stocks and the rest of the equity market. As the table below indicates, the 50 largest stocks in the Russell 3000 are up 4.1% in 2014 while the average return for the rest of Index (51-3000) is -1.1%. Since the small cap index (Russell 2000) peaked back on March 4, the divergence has been starker, with the 50 largest stocks up 3.8% while the rest of the index is down -4.9%.
There has been a nearly perfect relationship in 2014 between the size of a company and its return. The Chart below speaks for itself but I’ll make one comment on it anyway. The largest 500 stocks are up +2.7% since March 4 while the smallest 500 stocks are down -14.7%. That is a truly incredible spread.
Market historians will recall the term “Nifty 50” originated in the 1960’s bull market to describe 50 wildly popular large-cap stocks at the time. Interestingly, some of the same names from that list are leading the market higher today. The table below shows the Russell 3000 stocks with a market cap greater than $50 billion and returns greater than 5% year-to-date. The highlighted names were in the original Nifty 50, including Johnson & Johnson (JNJ), Merck (MRK), Walt Disney (DIS), Schlumberger (SLB), and PepsiCo (PEP) among others.
The question for investors, of course, is what this selective advance means for the markets going forward. Is it merely a benign rotation into cheaper mega caps or a harbinger of more difficult times ahead? Many seem to be arguing the former, using the fact that the major indices are still hitting new all-time highs and the trend is still up to make their case. Indeed, extreme bullish sentiment here confirms that most investors don’t seem to be bothered by the fact that the average stock has not been participating this year.
While it is hard to argue with these bullish investors (who could argue with “all-time highs”?), it is also hard to simply ignore the message that this selective advance is sending. In my view, that message is clear. The larger, institutional players are systematically rotating out of illiquid small caps names and hiding in names with the highest liquidity. They are at the very least anticipating a more difficult market environment to come and likely something more severe. This defensive rotation is not simply from small to large, but can also be seen across sectors (Utilities are the top performers in 2014, Consumer Discretionary bottom performers) and asset classes (Long duration Treasuries outperforming stocks and intermediate-term Treasuries). While the S&P 500 has ignored this defensive rotation thus far in 2014, the average stock has not.
Some food for thought the next time you read a headline about “all-time highs.”
This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.
Charlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts. He is the co-author of two award-winning research papers on Intermarket Analysis. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors, an institutional investment research firm. Previously, Mr. Bilello held positions as an Equity and Hedge Fund Analyst at billion dollar alternative investment firms, giving him unique insights into portfolio construction and asset allocation.
Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.
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