Bad news poured down this past week, yet the market kept on dancing in the rain.
There was bad geopolitical news as the U.S. blamed Iran for attacking two tankers carrying petroleum products. There was bad news about corporate profits as Broadcom (ticker: AVGO) lowered its full-year sales guidance by $2 billion. And there was bad trade news, as China continued to insist it won’t be pressured into a deal and President Donald Trump kept the pressure on.
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“The escalation of trade policy rhetoric and potential implementation is piling up to a degree that it’s no longer ignorable,” says Jason Pride, chief investment officer of private wealth at Glenmede.
And yet the market shrugged it off. The Dow Jones Industrial Average rose 105.67 points, or 0.4%, to 26,089.61 this past week, while the S&P 500 advanced 0.5%, to 2886.98, and the Nasdaq Composite gained 0.7%, to 7796.66.
After last week’s rally, the S&P 500 is up 4.9% in June and just 2% away from its record close. Still, there was one thing the S&P 500 couldn’t do—close above 2900, a level that has been identified as resistance by technical analysts, despite two attempts early in the week. From there, it was awfully quiet.
And for good reason—two of them, actually. First, there’s the meeting of the Federal Open Market Committee this coming Tuesday and Wednesday. Investors will be watching closely for signs that their hopes for a Federal Reserve interest-rate cut at the July meeting will be met. “I’m anticipating a change in the language, but no action taken,” says Carmel Wellso, director of research at Janus Henderson.
As soon as the meeting is finished, the market will turn its attention to the gathering of the G20 nations in Japan on June 28 and 29, when Trump and President Xi Jinping of China may meet, and may—or may not—reach a deal to end the trade war between the two countries.
We feel comfortable predicting a rate cut in the next few months, but what happens at the G20 is beyond our ken. Still, that means we’re left with just two different outcomes: a rate cut and new tariffs, or a rate cut and a de-escalation of the trade war. In the latter case, we can imagine the market taking off in a 1999-like rally of epic proportions, but we can also picture the former—and the decline that might follow.
When faced with what is essentially a coin flip, we look for trades that might win either way, and small-company stocks fit the bill. Consider: The small-cap Russell 2000 index has dropped 7.2% during the past 12 months, even as the S&P 500 index has gained 6.2%, observes Raymond James strategist Tavis McCourt, just the fifth time in the past 20 years that small has underperformed large by 10 percentage points or more based on monthly prices. That underperformance tends to reverse quickly. The last time it happened, at the end of March 2016, the Russell went on to gain 12% over the next six months, while the S&P 500 rose just 5.3%.
“This performance differential typically only lasts a few months and has historically resolved itself through relative outperformance by the Russell 2000,” McCourt writes. This could mean that both indexes rally but the Russell rallies more, or that both fall but the Russell falls less.
Either way, we’ll take it.
Write to Ben Levisohn at Ben.Levisohn@barrons.com