US Stock Market Bifurcation

Bifurcate - divide into two branches or forks.

I have spoken to dozens of investors of late and have tried to verbally explain what has been happening in the market. I describe that since the beginning of the year investors are reducing stock risk and they inevitably ask “how can that be when the major indexes are at all-time highs?” It is explained by a rotation out of the riskier, more volatile stocks and into the big cap stocks. This rotation has created a bifurcated market.  The chart below is performance of the US stock market since the start of the year by stock size. As you can see, the biggest stocks are up ~1% while the rest of the market is down ~4-5%.

Below is a 3-year look-back at the US stock market by (market-cap) size.  You can clearly see 1) the bifurcation that has developed (big cap = up, small and mid-cap = down) and just as importantly, this is a rare occurrence.   

I looked back at this relationship as far back as my charting tool will let me and it occurred only one other time in the last 20 years.  Interestingly, that time was in 2007, just before the SP500 began its second largest major historical decline. The timeline for that one occurrence was about 5 months as it started in June and ended in October when the SP500 peaked.

Remarkably, this relationship appears on the inverse and it’s just as rare, too.  Only once in the last 20 years did I find a time where the small cap and mid-caps moved higher while the bigger caps were falling. This occurred in 2002, at the bottom of the dot-com collapse, just before the market began its historic 100%+ run. The timeline for this occurrence was more than a year before it resolved itself.

What this all means or how it will resolve itself, no one knows for sure and only time will tell.  I have my theories but I have given up predicting the future (at least in writing :-> ).  But we do know that when rare events happen we need to stand up and pay attention.  The difficulty is these events unfold over many months and living the markets day-to-day you can be distracted by the noise as it will do everything it can to give you a multitude of false signals. Without going out on a limb and making a prediction here I will say that while this bifurcation can exist for a while, at some point all segments of the market will have to get back in synch.  That is the norm. The $64,000 question is will the small and mid-caps begin to out-perform the big guys in an attempt to catch up or will the big guys fall to match the levels of their smaller brethren? Considering market seasonality and past timelines, I think we will find out the answer to this question between now and the end of fall.