The IWM trailed the QQQ at one point this year by almost 20% points of relative performance. As of Friday, they are nearly matched with the NDX up 10.17% and the Russell 2000 up 9.09%. The prevailing narrative is rate cuts will cause outperformance to continue. Remember, at one point, the market expected seven cuts in 2024. Now, the market sees two or maybe three, depending on whether the Fed might choose a 50 bps to start. Why does the Fed cutting make the IWM “small caps” more attractive? Is it the narrative “long duration”? Is it they are debt heavy and will benefit from rate cuts? Or is it they are economically sensitive and a rate cut cycle will help?
All of the above and none of the above! A large part of the dollars invested in the markets nowadays if thematic, narrative and momentum driven. The money responds to pain even more than it does to gains. The Yen carry trade allows borrowing cheap in Japan and “carrying” all sorts of risk assets elsewhere. Look at this chart of the Yen weakness in 2024 and ask yourself how much of the “risk-on” was purely this carry trade?
See the air pocket down from 162 that started on July 11th 2024? The exact day the QQQ peaked at $502.96. We can keep telling ourselves that our “strategy” is to own the good companies (mostly ignore valuation) and over time it will be profitable and compounding. True, but your portfolio value ahead isn’t what you paid for Apple years and years ago. You “should” decide if what you own today has a still good risk reward. Japan’s stock market had LOST DECADES to account for over valuation, slowing growth and overly optimistic investor positioning. In summary, “other factors”, money flows and macro factors can determine the fair value of what you own. Take Microsoft, a juggernaut cash flow machine. The stock trades at 31.88 FY 2025 estimates. While the Fed cutting usually increases the P/E of stocks, it didn’t hurt them at all while they raised dramatically. If Microsoft earnings prove correct by Wall Street, would it mean much for the multiple to compress to 25x? A 7 multiple point compression on the $13.34 EPS estimate would be a drop of…..$93 from its $425.27 close on Friday!
None of this is meant to scare, but rather educate and remind. Back to the rotation question. Let’s take a look at the top IWM holdings of the diversified 2000 members:
Of the top 20 companies, I am familiar with a few. FLR, FN, ANF and HALO. I usually am able to rattle off growth, valuation and the story on most stocks I follow. Buying the IWM means you own a smattering of companies like these. Take INSM, the largest holding. Let’s look at their metrics:
INSM is a $12 billion market cap bio-pharma company that I wouldn’t buy with your worst enemies money! Kidding aside, the idea that rate cuts suddenly make INSM or any of the companies on the top member list more attractive is, at best, greater fool. The same way mentioning AI on your conference calls and the stocks rocketing up got out of control. However, perma bull market pundits like Tom Lee who likes stocks in almost any scenario has said the IWM has 20% upside before year end. Could he be right? Sure. Could he be forcing behavior (many have been long QQQ short IWM for years) that will peak as soon as the last dollar has been forced? Yes.
I kick myself, most often in hindsight when I look at the tools at my disposal and not identifying the narrative changes. Look at the QQQ and IWM TD MA2 which compares two different moving averages and their crossing patterns.
QQQ TD MA2
IWM MA2
Could it be any more obvious? Yeah, you didn’t know it would happen, but you certainly could see the risk of overstaying your welcome long QQQ when it felt like the Mag7 could do no wrong. I warned quite a bit on the risks, but I should have pointed out this flip which occurred around July 17th (btw the seasonal peak as well). Live and learn. More importantly, live, learn and share! That is why I write this substack.
Remember last week I wrote about what happens if we lose (they drop on earnings) Google, META and Tesla in the Mag7? We did. What if this week Microsoft or Amazon earnings aren’t enough? Scary thought, right? Nvidia’s market cap from its peak dropped around $625 billion, the size of the 55 INSM’s total market cap. The money didn’t disappear from NVDA, of course, but the dollars are lost from investors account balances. The market is cruel at the worst times when the most players are over their skis. The Yen at 162, over its skis. The QQQ at $503, over its skis. The IWM at its October 27th, 2023 low of $162.21, didn’t even have a pair of skis to put on!
So you ask, what is next for my $10 per month subscription? Of course, $10 per month gets you my crystal ball and absolute certainty! Good luck to you if you think anyone can offer that. What I can offer is when we hit the next inflection, I will be sure to point out to all my subscribers even more vocally and take the criticism of those who say “the trend is your friend” and respond….until it is the end!
Rob’s Educated Guesses
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