I’ve been repeatedly writing about the elevated risks arising in the equity markets, due to stratospheric valuations, and the most expensive stocks having massively concentrated weightings in the indices. Over the last week, we’ve seen those risks on display as small cap, value, and real estate stocks have been on absolute tear, while the Tech stocks are getting hit hard. This is what’s called factor rotation and while it has only been a week, I do believe it gives us a likely preview of what we would see in the next bear market. For instance, today, the Nasdaq 100 had its worst day since 2022, down 2.77%, and the Magnificent 7 were down by 3.4%. The weakness of the heavyweights caused the S&P 500 to be down by 1.4%, despite many stocks being up, largely due to the fact that Microsoft and Apple each count as about 7% of the index and they were down by quite a bit. TTCM portfolios were up, which is why I keep harping that I think we are very well prepared for the likely volatility that is coming.
Financial stocks and real estate stocks have been performing very well, with the banks posting fantastic earnings results. Real estate is rallying on the prospects of potential rate hike, as most of the selloff over the last few years has been due to the detrimental impact higher interest rates had on property valuations. Stocks such as VICI, Crown Castle, W.P. Carey, Agree Realty, Camden Properties, and MId-America are fantastic companies with strong long-term growth prospects. None of them have any material Office exposure, which is by far the most troubled area of the real estate market. Most of these companies will likely maintain and grow their dividends over the next 5-10 years, providing a stable and growing income stream for us as investors.
Over the last 5 days, small-cap stocks have had the biggest outperformance relative to large-cap stocks in history, since data was began being collected in 1978. This powerful rally is just a bit of mean reversion, as the opposite phenomenon had been occurring right up until then. This trend reversal might prove to be fleeting, or it might be the start of a major change. For those of you that remember the 2000 crash, even though the Nasdaq dropped 80% peak to trough, many value investors made fortunes because value stocks were so cheap going into that bear market. The mean reversion was powerful and lasted around 7 years. Hopefully we see a similar dynamic occur for value, but regardless I believe that we are well prepared. As always, we will keep you updated with however markets unfold from here.
Here is a short video where I discuss how the higher interest rate environment impacts various investments: Tim Travis – Interest Rates (youtube.com)