Riding the Carousel – Rotation Time?
Welcome to the latest installment of Buzzword of the Week!
On July 7th, 8th, and 9th, there were no Bloomberg financial-related headlines containing the mystery word. On the 10th, there was a single one. On the 11th, there were 7 and the flow has been steadily upward. Wednesday of this week saw 10. Thursday saw 18, and Friday had 19. The Wall Street Journal shows a similar wildfire spreading. There have been dozens and dozens of headlines after July 11 containing the Buzzword of the Week: Rotation.
When a word goes from zero to a hundred on the usage scale, it bears taking a closer look.
Why, all of a sudden, is rotation the hot topic?
The trigger was a massive upward move in small cap stocks (Russell 2000, +3.57%) and a simultaneous decline in large stocks (S&P 500, -0.88%) on July 11. This is indicative that what was working isn’t working any more. This may be the signal that the mega-cap, tech-heavy outperformance seen over the past two years is at an end.
Indeed, the small-cap performance gap has widened significantly since the watershed moment of July 11.
Source: Bloomberg
Another indicator that the tide is turning is market breadth. Even though the S&P 500 declined this past week, more than 300 of its constituents rose in value. The Russell 2000 outperformed the S&P 500 by the most in 24 years so far this month.
A day or a week doesn’t make a trend, but trends have to start somewhere and it looks like this is it. Note the frequency of rotation in the press. When rotation tapers off and leadership starts appearing more, then the new trends will likely be in place. We’re not quite at that point, yet.
Were we surprised? Absolutely not.
My colleague Paul Broughton hinted at rotation in his commentary two weeks ago in his final sentence: “But sometimes it’s wise to take the other side of a very crowded trade.” In her appearance Friday on Bloomberg TV, my colleague JoAnne Feeney went into deeper detail.
Source: Bloomberg TV
In her segment, she highlighted the continuing advance of the Russell 2000, marking its 13th day of outperformance in the past 15. With rate cuts coming, confidence to rotate into economically sensitive sectors is growing and macroeconomic data is encouraging. She was careful to point out that not all areas of the economy are thriving. The pinch of inflation is felt disproportionately by lower income folks. Perhaps the most salient point was that the stocks she talked about are long-term holdings in ACM portfolios: we have no knee-jerk reactions to make regarding the great rotation.
Were we prepared? Absolutely
Let me quote from one of the Bloomberg articles:
Yet for all noise, one trend is unmissable: Unloved fringes of the equity landscape – from small caps to banks – are suddenly on a tear and stock picking is back in vogue. […] Retail and institutional investors are looking to diversify into new market winners by sinking cash into everything from consumer stocks to health care…
Sudden? Back in vogue? The very nature of concentrated, diversified portfolios means that they will go for periods, sometimes extended periods, of underperformance when their style or focus is out of phase with the market. Nothing lasts forever, so the potential end of Magnificent 7 leadership is a welcome tailwind to out-of-phase portfolios.
Given the macro conditions, this is a market that is highly critical of disappointment and highly rewarding of positive earnings and upward guidance. This market does not have a sense of humor: it’s not a “rising tide lifts all boats” scenario. Poor performance is rewarded with a trip to the penalty box and management is put on detention. Like the article quoted above says, it’s a stock picker’s market. However, it’s nothing new: we’ve always been there. Correct, we can’t pick 100% of the “teacher’s pets,” but our aim is to tilt the game in our favor. A concentrated portfolio necessarily goes through periods of underperformance, but over time and by sticking to our guns, the great rotation will help us out.
We were there the whole time. Nothing to see here, people. Move along.
As the carousel turns, grab the brass ring. You might win an extra turn.
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