February 9, 2024
The cyclically-sensitive Russell 2000 (RTY) has underperformed large-cap indices since the late-December rejection of technical resistance near 2050. The RTY is outperforming today as the SPX flirts with closing above 5000. We have an open mind, but expect the RTY will find selling pressure on any advance toward 2050. In our opinion, RTY participation requires a cyclical economic recovery, which seems unlikely given late-cycle dynamics and highly restrictive real yields. The underperformance of the RTY relative to the SPX has reached record levels with an opportunity to deliver meaningful alpha once the relationship reverts to the mean. The relative underperformance and rare valuation discount in the RTY doesn’t mean it will outperform during a broad market pullback/correction/bear market. In fact, in that scenario we’d expect the RTY to underperform large cap indices by an additional 200-300bp. However, a cyclical recovery scenario driven by monetary easing and expanding money supply should result in 40-50% relative outperformance. Unfortunately, monetary easing and expanding money supply first requires a period of economic pain.
The 5000 level is psychological resistance only with technical resistance overhead in the 5095-5220 range. A currently benign macro environment characterized by falling rates of inflation and resilient growth has put downward pressure on realized volatility, leading to richer valuations. The SPX now finds itself at 20.5x twelve-month forward EPS estimates vs. a long run historical average in the mid-teens. The index can sustain the current multiple as long as macro conditions remain benign. When that changes, volatility will spike and the SPX will sell-off but will need to break 4800 to signal a short-term trend reversal. Any spike in the CBOE Volatility Index (VIX) above 20 would likely result in a break below 4800. The VIX currently rests at equity-friendly levels below 13 and an upwardly-sloped futures curve still implies a healthy respect for risk.