Inside Markets — Narrow Leadership

The small-cap, cyclically-sensitive Russell 2000 (RTY) continues to trade beneath key range resistance near ~2070. The four-month long equity rally has been characterized by narrow leadership in the largest stocks by market cap. Bull markets characterized by narrow leadership are generally considered more fragile than those with broad equity participation. While it’s not our expectation, a sustained RTY break above ~2100 would represent a broadening out of the rally for a more healthy and durable bull market.  A break above ~2100 may also kickoff a compelling catch-up trade in the RTY given the recent record underperformance vs. the SPX.

The 20.5x forward multiple on the SPX will only last as long as the macro environment remains benign or constructive. A benign macro environment always leads to lower equity volatility over time and a higher earnings multiple. Over the last ~5 months, the macro environment has been defined by solid growth, declining inflation and an intention to normalize monetary policy. The reacceleration in January inflation data may be a seasonal outlier, but it still represents a potential threat to the benign macro environment and the 20.5x forward multiple. We expect the next two months of inflation reports will help confirm the seasonal nature of the January data and calm fears of a reacceleration, but market participants could easily lose patience in the meantime. Equity markets will follow bond yields during this time. Equity investors will likely remain patient as long as 10-year yields remain below ~4.35%.