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Inside Markets — Rotation

Rotation

July 18, 2024

The rotation into cyclical/value and Russell 2000 (RTY) doesn’t yet look exhausted. The small two-day pullback in the RTY looks like the beginning of a short consolidation phase. All rotations regardless of their ultimate duration, magnitude or validity always start with a violent short covering rally that lasts from 3-5 days. The next phase is consolidation that can last a number of days or weeks. The rotation is only valid if the consolidation phase doesn’t include a material break below old range resistance (now support) at ~2140. At this point, the main justification for a small cap rally is the promise of a sustained easing cycle. Positioning dynamics are another major influence following two years of underperformance vs. large cap stocks. The performance differential between the RTY and SPX reached an all-time record of ~30 percentage points this spring and has only recouped ~8 percentage points thus far. And the RTY also still trades at a rare forward multiple discount to the SPX. The catch-up trade in small cap stocks is a compelling opportunity if we get an easing cycle without a material slowdown in economic growth. Price action should precede macro data and Fed guidance. A normal consolidation toward ~2140 followed by reacceleration and relative outperformance should be followed.

The SPX maintains bullish technical trend momentum above 5230, which is ~5.5% below current levels. A break below 5375 (~3% below current) would be the first sign of ‘technical trouble’ for the index. Reaching oversold territory in the weeks ahead while maintaining levels north of 5375 should be considered an opportunity to add exposure. The same rule should apply to the Nasdaq 100 (NDX) which maintains its bullish technical trend momentum above 18080, which is nearly ~8% below current levels.

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