Physicians' Guide to Wealth

A guide for anyone pursuing financial independence

Market Rotation

Dec 16, 2020

Overweighting in the large-cap sector (represented by the S&P 500) and especially growth large-cap, has been a winning strategy for the past three years compared to mid and small-cap (represented by the S&P 400 and S&P 600 respectfully). For the three-year period, the S&P 500 has gained 37.54% compared to 19.66% for the S&P 400 and 18.16% for the S&P 600 indices.

Understandably, during the volatile and uncertain year of 2020, investors continued to place their bets on larger companies, with the S&P 500 up 15.11% YTD compared to 10.34% for the S&P 400 and 8.0% for the S&P 600.

However, no sector or index remains the top dog forever. It’s only a matter of time that institutional investors will begin looking for new investment opportunities with some of the best prospects found in underperforming sectors. Investors may begin making this shift in their portfolios to take advantage of potentially discounted prices for greater future gains, increase their diversification, or to alleviate concerns the top-performing equities may be running out of steam.

Surprisingly, with all the uncertainties of the economy and pandemic, in November, institutional investors began shifting away from large-cap stocks to mid and small-cap stocks. After the markets bottomed on March 23, the S&P 500 began a solid recovery rally up to October. Then during October, the entire US stock market sold off, and all the major indices gave back some of the year’s gains. The S&P 500 had recovered from its steep sell-off in February and March but was up only 1.2% for the year by November 1. The S&P 400 and S&P 600 had also sold off during October but had never reached a positive return for the year, and the October sell-off drove these indices further in the red with YTD returns by October 31 for the S&P 400 of -7.89% and S&P 600 -14.16%.

Institutional investors resumed their buying on November 2 that rallied the S&P 500 12.3% through yesterday. However, the surprise with all the market consternation is investors’ focused on late in the riskier sectors of mid and small-cap companies. Since November 2, the S&P 400 has rallied 24.46% and S&P 600 18.39% bringing both out of negative YTD returns for the first time this year and easily beating a respectable 12.33% return of the S&P 500 since November 2.

What Does This Mean to Me?
Identifying when institutional investors begin shifting their portfolios can be huge buying opportunities for those that are paying attention. It remains to be seen if institutional investors continue to focus most of their new investments on mid and small-cap companies. Typically, investors begin investing into the riskier mid and small-cap sectors due to optimism for the future of the economy and project better returns with smaller companies able to adapt to new market growth. Investors possibly see a resolution to the Covid-19 pandemic and politicians easing health-related restrictions on businesses in 2021. It seems contrary to see such optimism considering all the reasons not to be. Nonetheless, institutional investors as a group have remarkable track records of accurately predicting the future for the economy, and it is encouraging to observe this recent shift with institutional investors.

Therefore, we maintain our favorable rating on the US economy and stock market. If the rotation from large-cap to mid and small-cap continues, we will be rebalancing our model portfolios as well.

Let us know if you have any questions about this UPdate or anything concerning your financial planning and investments. We appreciate your readership and welcome opportunities to be of assistance.

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