With equities under pressure, it may be surprising to see Small Caps holding up relative to Large Caps over the past two weeks. However, if the aftermath of the bursting of the dot com bubble were to serve as a guide, there is scope for further outperformance. As the markets shifts from a bullish to a bearish cycle, the “generals” are usually the last to fall. A look at some of the key market leaders uncovers some important reversals at the top of the market.
One of the more surprising dynamics in the market over the past two weeks has been the resilience of Small Caps relative to Large Caps. Given the risk-off dynamics currently at play, it would not be a stretch to think that Small cap stocks would lag. However, it is important to note that they have been lagging for more than a year after an initial surge from the COVID lows. Now, the ratio the Small Cap stocks to Large Cap stocks has retaken the 50-day moving average while remaining below the 200-day moving average. A move above the 200-day moving average could set the stage for further outperformance, even as the broader market remains under pressure.
The current setup is not dissimilar to what played out leading up to and following the busting of the internet bubble in 2000. The ratio is of Small Caps to Large Caps bottomed in April 1999, rallied until March 2000, and then pulled back before beginning another move to the upside. Recall that “the market” topped in March 2000.
What’s Happening Here?
Stocks are under pressure, but we note that for Small Caps, this is not new. Generally, as markets rotate from a bullish to a bearish trend, the lower quality, riskier, and small stocks are the first to show signs of weakness. Look no further than the holdings in the ARK Innovation ETF (ARKK). As the transition progresses, that weakness begins to move “up the market.” The generals, who had been leading the charge and propping up the market, began to come under attack. This is what could be happening now.
Looking at some of the key market leaders, we can see the progression playing out. Meta Platforms Inc. (FB) is below its pre-COVID highs. Amazon Inc. (AMZN) is breaking its pre-COVID highs. Alphabet Inc. (GOOGL) and Microsoft Corp. (MSFT) have broken their March 2022 lows and have room for the pre-COVID highs.
*This list is not inclusive and not meant to be a call on any of the individual stocks.
More recently, the bears have turned their attention to Apple Inc. (AAPL). It has been described as a haven within the technology space, but it is now testing support. Should weakness develop further, there is a lot of room down to its pre-COVID peak.
The weakness now playing out for the market’s “generals” will likely weigh on the Large Cap averages should it persist. This sets the stage for potential outperformance on the part of Small Caps, like what was seen in the aftermath of the dot com bust, as Small Caps have already corrected. It is still early, but this is a dynamic that investors may be well served to have on their radar.
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