The painful era of high inflation is unwinding before our eyes…
June’s consumer price index (CPI) showed inflation fell 0.1% month-over-month. It was the first monthly fall in consumer prices in over four years.
You don’t need me to tell you this is great news. Falling inflation is exactly what the Federal Reserve needs to pave the road to interest-rate cuts – which would provide relief throughout the economy.
But you must understand, this is no simple bull signal. One specific class of stocks is set to vastly outperform the crowd favorites.
After these numbers hit, we saw one of the largest stock rotations in history…
Investors sold one of the hottest groups (mega-cap tech) and deployed those assets into under-owned small-caps.
This is an important shift. Small-caps have been dead money for over two years. Now, they’re perking up and trading at their highest level since January 2022.
And believe it or not, these rare rotation events can shed light on what potentially lies ahead for both asset classes.
As I said a few short weeks ago, the great portfolio equalizer is imminent. It looks like this trade is now in full swing.
Pay attention closely today, because a massive opportunity could be here sooner than most realized…
One of the Biggest Rotations in History
It’s important to understand that money rarely leaves the market. Instead, it moves between asset classes seeking the best returns.
When a large macro event occurs, like the first monthly drop in inflation in more than four years, investors can hop off one train and onto another.
That’s exactly what transpired on Thursday after the CPI data hit. The consensus view now puts a 90% likelihood of the first Fed rate cut in September – essentially cementing the long-awaited pivot.
This sent traders scrambling out of one of the most crowded trades – mega-cap tech – and into areas primed to benefit from lower yields – battered small-caps.
If pristine balance sheets loaded with cash caused mega-cap tech to benefit from higher rates, it only makes sense that a falling rate regime would challenge that narrative.
On the flip side, the area penalized from higher rates – smaller, less-capitalized firms – will benefit the most from falling costs of capital.
The market clearly buys this idea. Thursday’s rotation sent the tech-heavy NASDAQ 100 (QQQ ETF) down 2.19% and popular small-cap benchmark Russell 2000 (IWM ETF) up 3.59%:
This move amounted to a daily “spread” of 5.79% – aka the distance between QQQ’s loss and IWM’s gain.
And looking back in history, we’ve only seen two spreads this size or bigger… and in recent history, we’ve seen similar action.
On Jan. 6, 2021, the IWM/QQQ spread reached 5.48%. Nov. 9, 2020, saw the spread reach 5.67%.
You can see them in the chart below…
With the naked eye, you may not spot the real opportunity ahead. But here’s where analyzing data comes in handy.
Why You Want to Follow This Rotation
I’ve been vocal about taking a stab at unpopular areas. As just one example, in late May I made the case to own the worst sector in the market, Real Estate. Since then, the Real Estate Select Sector SPDR Fund (XLRE) is up nearly 4%.
Now it’s time to make a similar call for the hated small-cap group. Here’s why…
When you go back in history and single out huge rotational days, where the spread between IWM and QQQ is 4% or higher, you’ll learn that small-caps in particular keep climbing.
Below shows this beautifully. Of the 23 prior instances where the IWM/QQQ spread reached 4% or higher:
- 3 months later, IWM ramped 5.9% while QQQ fell 1.5%
- 12 months later, IWM jumped 13.6% and QQQ slumped 4.2%
It’s important to understand that these rotational quakes tend to happen during trying macro times like 2000, 2001, 2008, and 2020. The fact that we’re seeing it today only reiterates the changing macro climate.
The main takeaway here is that you need to consider the possibility of changing market leadership in the months ahead. Beaten-down areas, choked by high rates, can finally start to thrive again. And that’s a great thing!
Areas that come to mind are homebuilders, REITs, financials, and select large-item discretionary plays like furniture, cars, and home repairs.
We could be on the cusp of a revival in the hated small-cap space… and you don’t want to miss it.
Shunned areas of the market will have their day in the sun again. Chances are it may already be here.
Regards,
Lucas Downey
Contributing Editor, TradeSmith Daily
His award-winning system pinpointed NVDA and META before both stocks doubled. Now it's flashing "BUY" on this under-the-radar A.I. stock. MORE HERE...
Source: Trade Smith