'Typically, it is small caps that move most dramatically off a market bottom,' says DataTrek co-founder Nicholas Colas
The bull market in U.S. stocks has been running for two years despite interest rates not moving much over that stretch - and investors seem confident the S&P 500's rally can keep going, according to DataTrek Research.
None of the rally can be "directly attributable to lower interest rates," which is "surprising," said Nicholas Colas, co-founder of DataTrek, in a note emailed Monday. "Interest rates are almost exactly where they were 2 years ago, unlike most 'early cycle' rallies that see lower rates."
While yields on the 2-year and 10-year Treasury notes have "meandered higher and lower" over the past two years, "their journeys have returned them to almost the same spots from whence they started," he said. Colas highlighted the path of Treasury yields from Oct. 12, 2022, to Oct. 14, 2024 - the period corresponding to the equities bull market that just celebrated its two-year anniversary - in the chart below.
The S&P 500 index SPX climbed to another all-time high on Monday, booking its 46th record close of 2024, according to Dow Jones Market Data. The index, which is a benchmark for large-cap stocks in the U.S., finished Monday up almost 23% so far in 2024.
Small-cap stocks, as measured by the Russell 2000 index RUT, have trailed in the latest bull market.
"Typically, it is small caps that move most dramatically off a market bottom," Colas wrote. "Such has not been the case this time around because interest rates have remained high and relatively stable over the last 2 years."
So far this year, the Russell 2000 has gained 10.9% through Monday, lagging far behind the year-to-date gains for the S&P 500, according to Dow Jones Market Data.
Colas looked at the performance of equities indexes over the past two years to mark returns for the two-year anniversary the bull market celebrated on Saturday, Oct. 12, finding that the 33.2% two-year return of the Russell 2000 trailed the S&P 500's 63.8% gain over the same stretch.
The bull market has been "quite atypical" in the last two years, Colas said, with growth stocks beating value stocks, while large-caps outperformed small-caps and the U.S. bested equities in the rest of the world. That's the result of the "early cycle" of the bull run being unusual for not seeing lower rates, he explained.
The yield on the 2-year Treasury note BX:TMUBMUSD02Y was trading about flat Tuesday afternoon at around 3.96%, while the 10-year Treasury rate BX:TMUBMUSD10Y fell about 7 basis points to around 4.03%, according to FactSet data, at last check.
U.S. stocks were trading down Tuesday as investors weighed the latest batch of Wall Street bank earnings, with the Dow Jones Industrial Average DJIA falling 0.6%, the S&P 500 SPX shedding 0.6% and the Nasdaq Composite COMP dropping 0.8%, according to FactSet data, at last check. The S&P 500's financial sector was rising, but information technology, the index's biggest sector, was dropping sharply Tuesday afternoon.
The fact that S&P 500 sector correlations have fallen from their mid-September highs confirms "the now 2-year-old bull market in U.S. large caps remains alive and well," Colas said.
Sector correlations to the market typically rise when "investors are worried about macro issues like recession or geopolitical uncertainty," because company earnings tend to broadly fall in an economic contraction or slowdown, Colas said. By contrast, correlations declining far below the long-run average signals that investors may have become "too brave."
But currently at an average of 0.76, "correlations are nowhere low enough to raise the specter that investor confidence has once again gotten too high," he wrote.
"We are in 'goldilocks zone,' where investors are rightly trying to pick winners and avoid losers but are not so optimistic that they have thrown caution to the wind," Colas said. "Within U.S. equities, we like technology and cyclicals and also think small caps have room to play catch up."
-Christine Idzelis
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