Leaders-Laggards

The small-cap rally, especially relative to the S&P 500, has been impressive, but the one thing I’d feared here looks like it might be happening - getting rejected at its 52-week highs. Despite getting stretched thin, the long bond rally isn’t necessarily done yet, but it needs conditions to match up with expectations to hold on to these levels. Interesting to see that defensive equities staged a minor comeback to close out the year, a time when low volatility generally favors riskier strategies.

The retail sales numbers for November and early holiday sales figures should shore up confidence in the near-term. The breakout to new multi-year highs for small-caps has officially happened, which means that this run could have longer legs and strength than prior more narrow rallies. Long bonds have obviously made significant gains, but even ultra-short Treasury bills are starting to see their yields drop in anticipation of rate cuts in the first half of 2024.

At a macro level, the credit contraction is the biggest long-term threat to financials, but investors are reacting currently to how margin pressures are declining due to the rate decline. I think it’s important to remember here that the Fed begins cutting rates because they see cyclical weaknesses ahead and rallies tend to be short-term in nature. The cyclical rally is giving dividend stocks a lift here, but the defensive nature of many payers is acting as a counterweight.