Topline
David just trounced Goliath on Wall Street, a potentially worrisome occurrence considering the concentration of the recent rally in the world’s largest stocks, but research suggests that smaller stocks outperforming the giants can be a healthy development for the broader market, at least in the short term.
The stock market rally may be broadening out.
Key Facts
Thursday was the best relative day for smaller stocks in several years by numerous metrics.
The Russell 2000 index, which tracks 2,000 smaller public American firms with a median market capitalization of $900 million, gained 3.6%, while the tech-leaning Nasdaq 100 declined 2.2%, the second-largest spread between the indexes’ daily performances of the last decade, according to FactSet data, while the 10 largest stocks on the S&P 500 index underperformed the other 490 constituent stocks by the fourth-largest margin of the last 20 years, according to UBS research.
Notably, it was the worst performance by the “magnificent seven,” the seven artificial intelligence heavy stocks like Nvidia and Microsoft behind much of the broader rally over the last two years, since Oct. 2022, according to Deutsche Bank strategist Jim Reid, as the septet fell a collective 4.3%.
The trend of small-cap outperformance continued Friday, as the Russell 2000 gained 1.8% and the Russell 1000, which encompasses the 1,000 largest American stocks, rose 0.7%, and the magnificent seven stocks rose an average of 1.1%.
The shift feels unsavory considering how top heavy the market is, but history suggests that further gains can be had.
UBS strategist Patrick Palfrey wrote to clients Friday that during the five other most comparable times that the 490 smaller S&P stocks outgained the leading 10 stocks during a day like Thursday, the S&P rallied a further 4.5% over the next month despite the top 10 stocks falling an average of 4.8% over the same stretch.
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Crucial Quote
“The performance gap between tech and the rest of the market is so wide that it’s reasonable to expect continued closing of that gap as markets more fully embrace the idea of the start of a rate cutting cycle,” summarized Sevens Report founder Tom Essaye, noting in the “near term” non-tech sectors may mount a catchup rally. Essaye is referring to Thursday’s strong inflation data which bolstered calls for the Federal Reserve to soon lower interest rates, which broadly help most equities but tend to favor certain rate-sensitive sectors like real estate.
Big Number
33%. That was the weight of the magnificent seven—Apple, Microsoft, Nvidia, Google parent Alphabet, Amazon, Facebook parent Meta and Tesla—on the market cap-weighted S&P at Thursday’s close, according to FactSet data. In other words, the septet’s combined market capitalization of $16.4 trillion is equivalent to the total valuations of the index’s 427 smallest constituent stocks.
What To Watch For
How the nascent second-quarter earnings season impacts perception of the top heavy market. The magnificent seven’s forecasted 27.8% combined annual earnings growth during the period is about five times higher than the other 493 companies’ projected 5.2% profit expansion, according to Bernstein quantitative analyst Ann Larson.
