Get Ready for a Monster Small Stock Rally

The major averages began the week with a whisper.

The Nasdaq Composite dropped just 18 points. The Dow rose 21. The S&P 500 finished the day right where it started. Ho-hum…

All’s quiet in the markets. Has the post-election turmoil run its course?

Nope.

Under the surface of the S&P and Nasdaq, a furious rotation is whipping some of the biggest stocks on the market into a frenzy.

The famous FANGs– Facebook, Amazon, Netflix, and Google— all finished Monday trading in the red, extending their Friday declines. While investors fight to get out of these household names, they’re ripping each other apart to get into big banks, railroads, and health care stocks.

It’s a brave new world. Money is pouring out of some of the best performing stocks of the past two years and into the forgotten corners of the market. And right now, the most powerful post-election surge belongs to small-cap stocks.

The market gods will forgive you if you haven’t been playing attention to small-caps lately. As a group, small-cap stocks haven’t exactly set the world on fire since they started breaking down in 2015.

While the major averages endured months of choppy action, the Russell 2000 small-cap index fell of a cliff.  After topping out nearly 18 months ago, the Russell plummeted nearly 30% peak to trough. That a bonafide bear market, in case you’re keeping score at home.

But small stocks have finally snapped out of their slumber. Bottoming out with the broad market back in February was the first hurdle. Now, after a swift pullback in October, small-caps are finally back on top again.

The Russell 2000 posted a new all-time high yesterday. It’s now nearly 40% above its February lows and ripping higher. Heck, while the major averages barely budged to begin the week, the Russell jumped another 1.2% yesterday.

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Since November 1st, the Russell has jumped 9%. The S&P 500 has gained less than 1.8% over the same timeframe.

Of course, the financial media is desperate to explain the sudden small-cap resurgence…

“President-elect Donald Trump’s promises to prioritize American corporations is doing wonders for the smallest companies in the stock market,” Bloomberg blares. “Small-cap shares had the biggest single-day rally over the larger peers in five years [last] Wednesday… The reason may be speculation Trump’s homeward-looking policies will favor the more domestic small-cap index.”

Whether or not this is true remains to be seen—although I’m sure that any mention of Trump is still grabbing eyeballs right now. Also, financials make up 27% of the Russell, Bloomberg notes, compared with 14 percent in the S&P 500. At the same time, the Russell is also lighter on tech stocks. That’s a much more favorable makeup in this trading environment…

Last week, the Russell posted its best 4-day stretch in 5 years. As a result, many small-caps are overheated at the moment. In fact, futures are indicating that the Russell will open in the red this morning. That’s fine. We’re going to need to see many of these stocks cool off before we can safely hop onboard for a trade.

What we’ve witnessed over the past week is the beginning of a huge small-cap rally. Expect these tiny champions to lead the market melt-up into 2017…

Sincerely,

Greg Guenthner
for The Daily Reckoning

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