It’s beginning to be like a broken record in this newsletter during the current bull market. The more things change the more they stay the same. Once again, we are seeing persistent strength and near record highs at the index level and rotation beneath the surface. Last September we discussed how banks and small-caps were lagging the overall market while the Mag 7 accounted for over 30% of the entire S&P 500, and if ever there were a time for a shift to take place it would be now. Fast forward to today and the Mag 7 are being dubbed the “Lag 7” because while the markets are printing fresh highs Mag 7 are in “correction” territory, down around 10% as a group. Nvidia and Tesla are down roughly 16% and META (Facebook) is down over 30% from its high.
In a bull market we expect to see this. It’s normal to have leadership rotation and it’s especially encouraging since it’s happening at the same time that breadth is still expanding. Due to the huge weighting of the mega-caps, some strange price action occurs even in an advancing market. Just the other day the majority of stocks in the market were up but the index was down over 1% as investors rang the register and took their gains primarily from mega-cap tech and sought out smaller companies further out on the risk scale for potentially larger gains (a healthy sign of risk appetite expanding). As a result of this ongoing rotation, small-cap stocks have had their strongest first 6 months in over two decades. While that is great news for the bull market and for diversified portfolios, the best part about that is the underlying implication. The types of stocks within the small-cap space that funds are being allocated to are technology and financials – two areas you want to see doing well in a strong economy and healthy market.
The AI fear mongering will have us believe that new AI tools will eat all the software companies and smaller innovators and start-ups will be wiped out and made unnecessary since the machines will be able to do the work of whole organizations and innovate on the fly. While that may become more true in the future, today we still need tech companies and human teams working with AI tools to innovate and invent the technologies of tomorrow. And in order for these smaller companies to grow and innovate they usually require raising capital, and banks sit right at the center of it all.
Fear seems to be creeping into the American consciousness though as a new study by insurer Allianz found that 62% of Americans believe a major recession is right around the corner and only about 25% believe it is a good time to invest. The market is saying otherwise, however. Banks are just now breaking out of a 20-year base. Essentially, the banking sector has been licking its wounds for the last two decades, repairing the damage caused during the Great Financial Crisis. When major drawdowns take place in a stock or sector, often times what happens is investors that came in at or near the top will hold onto that position until they make their money back. That’s why these levels can act as areas of resistance in price. Eventually, however all the old sellers exit their position and supply dries up. That’s when you see the price meaningfully break through that level and advance to new highs. This also usually coincides with strong underlying fundamentals or reasons to get back into that sector.
Banks aren’t like the other areas of the economy; they sit at the center of the economy. Every major financial transaction (for now, at least) requires a bank. Cryptocurrencies and blockchain technologies are trying to change this, but in the meantime the major banks still run the show. When the economy is healthy, lending expands, businesses invest, and consumers borrow and spend. The opposite happens in poor economies and banks struggle. That’s why healthy banks are so meaningful to lasting bull markets. If the economy were truly on the verge of an economic crisis or recession it would be very unlikely to see bank balance sheets and investor appetite this healthy. This is evidence that the bull is still in good shape to keep trotting on.