Insights & Advice

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Market rotation continues

One day, it’s all about technology. The next day, back to commodities. And on the third, defensive plays like healthcare shine. Next week, we could see a new player lead the markets higher.

The Russell 2000 Index, which is chock full of small cap stocks, has been trading back and forth, but basically going nowhere over the last month. I detected a stirring of upside momentum this week and will be watching that index closely after the Memorial Day weekend for additional follow-through.

The small cap universe, (one of my picks to outperform this year) has done “okay” so far this year, outperforming the S&P 500 Index by about 3%. But I expected more. After all, small cap stocks are the ultimate re-opening trade. They are the lifeblood of the U.S. economy, and should do especially well when the broad economy is growing at a substantial clip. The macroeconomic data indicates that is happening right now.

The first quarter’s GDP growth came in at 6.4%. The median forecast for the second quarter is another gain of 9.3%. I think that qualifies as a growing economy. So, what’s with the Russell? Some market analysts believe inflation fears are responsible for the Russell’s recent weakness. Higher producer prices could be creating a profit squeeze on small businesses. Unlike mega corporations, smaller companies often do not have the pricing power to pass along higher input costs to the consumer.

As readers know, Wall Street has been wrestling for weeks over whether higher input prices are the start of a prolonged inflationary cycle, or simply transitory, as the Federal Reserve Bank maintains. A key U.S. inflation gauge, the core personal consumption expenditure price index (PCE) for April increased 3.1% during the last 12 months. Fed officials consider this the best gauge of inflation, which was faster than expected. However, the market reaction was a big yawn since the sentiment pendulum (for now) has shifted away from the ‘inflationistas’ and towards the Fed’s “don’t worry, be happy” position. If this trend in transitory sentiment continues, it could mean a period of out-sized gains ahead for the small-cap universe.

Of course, life would not be complete without some mention of the latest political theatre down in Washington. The Republicans are offering their third counterproposal for an infrastructure program. This time, the headline figure is $928 billion, but only $257 billion is new spending, while the rest is a paper shuffle of moving unspent funds from already-passed stimulus spending programs to infrastructure. That is a far cry from President Biden’s $1.7 trillion in new spending.

Republicans fail to mention that President Biden’s program will be spent over the next decade and not over one year. However, in a vacuum, $1.7 trillion sounds like a lot of money, but in comparison to other countries, it’s not much.

If we compare the proposed U.S. infrastructure spending package of the Biden administration versus the existing amount being spent by China, our supposed new arch enemy, Republican arguments are ludicrous, and possibly even dangerous. In 2020, for example, the Chinese spent $8 trillion, which was a 2.9% increase from 2019. And in 2018, China’s average infrastructure spend was 10 times higher than that of the U.S.

One might ask how this country could possibly be able to retain our global position, and defend our nation, both economically and militarily, under the GOP proposal?  Remember, infrastructure is also part of a nation’s strategic defense system. I would argue that we are not spending nearly enough to compete in the years ahead with China as well as other countries.

Over in the cryptocurrency world, we face a three-day weekend, which is more than enough time to play havoc with the prices of Bitcoin and Ethereum.  Remember, if the $33,000 level fails to hold on Bitcoin, I could see a fast revisit to $20,000. Gold, on the other hand, broke its long-standing resistance of $1,900/oz for a moment. I expect that precious metal will continue to move higher.

As for the markets, investors continue to play the rotation game. Technology, re-opening plays, commodity, and material stocks have a day or two in the sun before falling back as another group moves forward. It creates a churn in the market, which fortunately has produced a slow grind upward in the overall averages. I expect that to continue.

 

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires.  Bill’s forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners, Inc. (OPI).  None of his commentary is or should be considered investment advice.  Anyone seeking individualized investment advice should contact a qualified investment adviser.   None of the information presented in this article is intended to be and should not be construed as an endorsement of OPI, Inc. or a solicitation to become a client of OPI.  The reader should not assume that any strategies, or specific investments discussed are employed, bought, sold or held by OPI.  Direct your inquiries to Bill at 1-413-347-2401 or e-mail him at email hidden; JavaScript is required. for more of Bill’s insights. Investments in securities are not insured, protected or guaranteed and may result in loss of income and/or principal.  This communication may include opinions and forward-looking statements, and we can give no assurance that such beliefs and expectations will prove to be correct.Investments in securities are not insured, protected or guaranteed and may result in loss of income and/or principal.  This communication may include opinions and forward-looking statements, and we can give no assurance that such beliefs and expectations will prove to be correct.

 

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