A cooler than expected inflation report early in the week was all it took to pull investors back into the market again. This past week looked awfully similar to the one a few weeks ago when the Fed meeting and Powell’s more neutral tone helped put a near-term bottom into stock prices. Both featured small-caps leading large-caps, rate-sensitive sectors, such as utilities and real estate, performing especially well, Treasuries ripping and the dollar pulling back. November has unquestionably been a good month for the major asset classes - large-caps, small-caps and long-term Treasuries have all netted gains of 7-8% - but now we enter the period where we must see if those gains are sustainable or it’s just the latest bear market rally.
I’ve been saying that small-caps are the key here because valuations are likely going to become much more important in the coming months. The tech sector is still trading at around 27 times earnings and, while you can work to make the argument that those valuations are justifiable when interest rates are near zero, it’s much more difficult to do so when the Fed Funds rate is over 5%. That contradiction has to be normalized at some point and that’s why the behavior of small-caps is so important here. If small-caps can create some sustainable momentum relative to large-caps, which hasn’t really happened since 2022, it could be a sign that investors are finally giving up on expensive mega-cap growth stocks and giving value another chance.
Keep reading with a 7-day free trial
Subscribe to The Lead-Lag Report to keep reading this post and get 7 days of free access to the full post archives.