Equal opportunity recovery weaning S&P 500 of the index’s megacap habit

While the rally took a breather last week, it remains the best annual start for US equities in almost three decades, with $1.7 trillion added to share values. Notable in the surge has been the role of smaller companies — or less-gargantuan ones, anyway. An equal-weighted version of the S&P 500 that strips out market-cap biases is beating the regular gauge by 2.3 per centage points.

A small advantage, to be sure, but a sign of breadth that has been absent as market leadership got squeezed into a narrower cohort over the past few years, alarming analysts. At present, the equal-weighted S&P 500, which gives a relatively small company like H&R Block Inc. the same influence as Apple Inc., has beaten the cap-weighted gauge for six consecutive weeks, the longest streak since 2016.

“When we have a healthy market environment, that’s something that tends to happen — a rising tide lifts all boats,” said Jack Ablin, Chief Investment Officer at Cresset Wealth Advisers. “Maybe the market has decided that the outperformance of the Nvidias of the world isn’t going to continue.”

Eight of the 10 biggest gainers in the S&P 500 this year are companies with market capitalization of less than $30 billion. Driving that has been the Federal Reserve’s dovish stance on rate hikes, a potential tailwind for companies with more leverage, and a rotation away from technology and into industrials and real estate, where fewer giants reside.

In a week when US stocks failed to rise past their 200-day moving average, the gauge of equal-weighted stocks provided a cushion. Broader market participation and a break-out in small and medium-sized stocks is generally welcome by analysts and is good for stock pickers, too.

It hasn’t been a clean sweep for the size factor. Four Fang megacaps — Alphabet Inc., Inc., Netflix Inc and Facebook Inc. — continue to surge. But a gauge of the 100 largest stocks is trailing the broader market, rising 9.2 per cent this year, compared with a 11 per cent gain in the S&P Midcap 400 and a 12 per cent advance in the Russell 2000 Index. Last month, the equal-weighted index outperformed the S&P 500 by the most since 2011.

Broader market participation at least begins to assuage concern about the market’s uneven bounty, in which it has sometimes seemed like five or six stocks account for the entire return. Between the 2016 presidential election and the market peak in September, Nvidia Corp., Netflix Inc. and Inc. were among the 20 biggest gainers.

In 2019, Xerox Corp., with a market value of $6.7 billion and Mattel Inc., the $5.3 billion toy manufacturer, have spearheaded the advance. The Fed’s about-face on rate increases mitigates smaller firms’ concerns about cost of debt and could be one reason for the rally. Optimism that growth in the US isn’t slowing as fast as some predicted in December is another. Whatever the reason, a broader advance is a good thing for markets, according to Miller Tabak + Co.’s Matt Maley.

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