Stock investors are turning to roughed-up corners of the market from small caps to value shares as they seek out bargains with the S&P 500 Index riding a five-week winning streak and soaring almost 9% since the start of November.
To see it, look at the S&P 500 Equal Weight Index, which is up more than 10% since Oct. 31 compared with the S&P 500’s 8.9% rise. In December, the equal weight version of the S&P is up 1.1% while the regular index is flat. It’s still early, but that holds it would be the second-best month relative to the broader benchmark index since October 2022, according to data compiled by Bloomberg.
The move comes as the seven largest stocks in the S&P 500 by market value — Apple, Microsoft, Google parent Alphabet Inc., Amazon.com Inc., Nvidia Corp., Tesla Inc. and Facebook owner Meta Platforms Inc. — waffle after dominating the market for most of 2023. Combined they account for more than a quarter of the index’s weight.
Much of the optimism for stocks more broadly is coming from investors’ expectations that the Federal Reserve is done with its interest rate hikes to tame inflation and will cut rates in 2024.
“The expectation that the Fed is done raising rates has been a catalyst for investors to buy the ignored corners of the market including things like value shares and small caps,” said Todd Sohn, managing director of ETF and technical strategy at Strategas Securities. “This is bull-market behavior as the rally begins to broaden out and it also serves as a hedge for retail and institutional traders who want to protect their portfolios against a potential top in megacap stocks that have cooled off.”
The improved stock market breadth is also apparent in the small-capitalization Russell 2000 Index, which is up 13% since the end of October, beating the S&P 500 over that time after lagging badly through first 10 months of the year. Small- and mid-cap exchange-traded funds are also seeing stronger inflows since mid-November, according to Citigroup Inc. strategist Scott Chronert.
“You have the best of both worlds: Rates coming down will relieve pressure on small caps’ margins next year, and the economy holding together better than people thought,” said Vincent Deluard, StoneX’s director of global macro strategy.
Looking at big cap stocks, the equal-weighted version of the S&P 500 is likely to outperform the cap-weighted version due to lower earnings volatility, lower valuation and less crowding, said Bank of America strategist Savita Subramanian, who dubbed it the firm’s “highest conviction call.” In addition, the bank’s macroeconomic regime indicator suggests US equities are in a “recovery”, which is when the equal-weight S&P 500 typically beats the cap-weighted version, BofA data shows.
Healthy flows into large-cap equal-weight equity funds suggest that investors are using them to allocate away from traditional benchmarks due to the narrow leadership in Big Tech, said Strategas’s Sohn. Investors have poured $1.7 billion into the Invesco S&P 500 Equal Weight ETF (RSP) over the past month, according to data compiled by Bloomberg Intelligence.
Now with the year coming to a close, many active managers who entered 2023 positioned for losses are trying to make up lost ground, creating even more demand for beaten-down stocks with upside.
“Active managers who broadly underperformed are trying to play catch up,” said Cliff Hodge, chief investment officer for Cornerstone Wealth.
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