The S&P 500 is essentially flat through the first two weeks of the year. However, other areas of the market are off to a hot start. In the US, mid cap and small cap stock indexes are up more than 5% and 8%, respectively. Around the globe, international and emerging market indexes are up more than 2% and 5% each. This type of performance variance has been common in equities for much of the last few years, but with one key difference. Prior to six months ago, it was the S&P 500 that was out performing everything else.
Mid and small is on fire
The first chart below highlights the year-to-date (YTD) performance of three index ETFs: SPY, which tracks the S&P 500 (a large cap index), IJH which tracks the Mid-cap 400 (a mid cap index), and IJR, which tracks the S&P 600 (a small cap index):
The second shows the performance of all three over the last six months. Notice that the starting point of outperformance for IJR and IJH coincided with the 2020 election:
Prior to the election all three indexes had been tied together at the hip. Post-election, however, it’s been a different story. For whatever reason, there’s been a clear rotation into small and mid cap over large cap since the election.
Similar trends elsewhere
We’re seeing similar trends outside of the US too, where international and emerging market stocks have started the year off strong. The first chart below shows the YTD performance of SPY compared to two non-US index ETFs: VEA, which tracks an international stock index with heavy exposure to Japan and Europe, and VWO, which tracks an emerging market stock index with heavy exposure to China.
While SPY, representing the S&P 500, is flat YTD, international (VEA) and emerging markets (VWO) are up more than 2% and 5%, respectively. Similarly to the performance of small and mid caps in the US, the outperformance appears over the last six months as well:
However, this outperformance is relatively new and didn’t clearly coincide with the US election in November. Rather, it seems to have a more random starting point beginning in the early part of December. Yet, if we look back over the last five years, the S&P 500 has solidly outperformed versus her global peers:
Will recent trends persist?
While the entire world’s stock markets have enjoyed a strong rally since the March 2020 bottom, performance is starting to deviate across market segments and regions. The S&P 500 has been the best performer for a long time, but that has changed in the last six months and it has accelerated even more recently. Predicting if this new trend in favor of small caps or emerging markets will persist is extremely difficult, if not impossible. The takeaway here isn’t in figuring out which market segment to overweight or underweight, but in realizing the benefits of diversification.
A diversified portfolio, with exposure to all of the various market segments and regions listed above, will always benefit from a market uptrend, regardless of who is leading the charge. Lagging performance from the large cap portion of your portfolio over the last few weeks is being offset by strong performance from the small cap portion. But that’s only if you already had that small cap exposure in place prior to this big rally starting. Rather than try to guess how long any one trend will last, remember that performance is impossible to predict and can change randomly. To benefit from the randomness of changing market trends, you need a diversified portfolio. We think the graphs referenced above are a good reminder of that.
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