12/14/25
S&P 500: 6827
Nasdaq: 23,195
10 Year Treasury: 4.1%
David R. Snyder, CFA
The recent outperformance of small caps and some value cyclical sectors such as consumer discretionary will likely not last for more than six to nine months. They began their outperformance in early December after extreme underperformance and when it became clear that the Fed was going to lower rates in December. This reminds me of the trade from October of 1998 through June of 1999 when the Fed was lowering rates and ex-tech sectors including financials and small cap, had a strong rebound. As for small caps, earnings will likely rebound strongly next year, possibly more than large cap, but that doesn’t guarantee outperformance. In 2018 the S&P 600 (small cap) grew earnings much faster than the S&P 500 (large cap) but still underperformed. Also, it isn’t just renewed earnings growth that moves the market for small caps, it is whether earnings in the future are higher than expected. This rotation will just be a trade as AI and large cap growth are going to lead this market higher until the secular bull ends. International will outperform once this bull market is over.
There have been numerous short term periods over the last few years when there has been broadening of the stock market and investors prematurely call for a lasting rotation. For example, the equal weighted S&P 500 would outperform the S&P 500 over the last two years when there have been corrections in the S&P 500, but they didn’t last once the S&P 500 turned higher. There are always a few sectors that become so absurdly undervalued that can play catch-up such as healthcare this year, but overall rotation has just been trading opportunities. I have not bought in to the broadening stock market thesis.
I wrote negatively about small caps in early 2014 when its relative outperformance was peaking and stayed negative until April of 2020 when I wrote that it would outperform. In April of 2021 I wrote that the small cap rally was over and have stayed negative since then but now see a short to intermediate term rally. Small and mid-cap equities at a 16 forward P/E are not expensive unlike their large cap peers, but they are not especially cheap either.
When the AI trade dies, the secular bull market will end. There is no precedent for a generational new technology leading a stock market rally and then ending without pain in the S&P 500 Index. Small caps, value, and international can outperform for a time period after the new technology crashes as they did from March of 2000 to March of 2002, but they ultimately collapse with the S&P 500. In absolute dollars even these other outperforming sectors made little or no money for investors from March of 2000 to March of 2003. Also, the Value Line median annualized appreciation potential is now in the bottom 20th percentile, whereas in March of 2000 it was in the 80th percentile. The Value line Index is an unweighted index of 2250 small, medium and large cap stocks, a broad index.
Every secular bull market ends with overbuilding of the new generational technology advancement and the start of a major secular decline in the stock market. The Panic of 1893 was a result of overbuilding of the railroads and speculative railroad mania in the stock market. Railroads had spurred the long secular bull market that began in 1863 with market capitalization from railroad stocks reaching as high as 80% of the stock market. The “Roaring Twenties” secular bull market was the result of a technological shift of electricity surpassing steam as the primary source of power and of course automobile ownership increasing from 20 to 62%. Overbuilding of these new industries combined with speculation led to the end of the secular bull market and the Great Depression. In the 1960’s there was the first real technology boom led by computers, semiconductors, electronics and photography, along with advanced aerospace technology for the race to the moon. Integrated circuits (microchips) first became massed produced in the late 1960’s and again overbuilding and speculation led to the secular bear market that didn’t end until 13 years later. Finally, we had the greatest speculative bubble ever in the late 1990’s with the internet that led to the end of the secular bull market in 2000 when the bubble burst.
Full Disclosure: I own several of the securities mentioned positively. None have been purchased within the last month. The opinions merely represent the opinion of the author as CIO of Journey 1 Advisors, LLC and intended to inform the readers about our investment philosophy and strategy. The contents of this report are based on sources believed to be reliable. It is not intended for circulation. It is not intended to offer investment advice, or to recommend the purchase or sale of any securities or investment product. Investment advice is only given after a client has signed an investment advisory agreement with Journey 1 Advisors, LLC and will be subject to the terms and conditions therein. Your decision to buy or sell a security should be based upon your personal investment objectives and should be made only after evaluating the stock’s expected performance and risk.