Small-Caps: The Next Bull Market?

The S&P 500.

It’s famous. It’s legendary. It’s always being talked about.

This American large-cap index is so prominent, it seems to exert its own gravitational force on the stock market, doesn’t it?

In fact, just yesterday, I was browsing the financial news while having my breakfast. And — lo and behold — I came across the S&P 500 being mentioned 21 times. And I was only halfway through my bowl of cereal.

Source: Leverage Shares

Historically, it’s not hard to understand why the S&P 500 is so popular:

• A 40-year snapshot of the index reveals a pleasing track record. Yes, investors have experienced rainy days roughly 18% of the time. But the other 82% of the time? Well, investors have enjoyed sunny days. Happy days. Profitable days.

• So, with an average annual return of 12.6%, what does the power compounding look like? Well, an imaginary sum of $100,000 invested at the beginning of 1984 would have mushroomed to over $11.5 million by the end of 2023.

• As they say: ‘Success breeds success.’

Of course, past performance is no guarantee of future. Still, in the present day, it’s impossible to escape the euphoric mood in the market:

• A lot of punters are still feeling bullish about American large-caps. They are clearly setting the pace for the rest of the world. This is especially true as the artificial-intelligence craze tightens its grip.

• But is there a downside to this? Well, if you look closely at S&P 500, you will notice that it seems to be top-heavy. It is dominated by the giants. In particular, the so-called Magnificent Seven — Nvidia, Alphabet, Amazon, Apple, Meta, Microsoft, and Tesla.

Source: Image generated by OpenAI’s DALL-E

In 2023 alone, the Magnificent Seven delivered a return of more than 100%:

• Within the S&P 500 index, these goliaths occupy the pole positions. The Magnificent Seven have attracted an influx of cash, while overshadowing everybody else.

• At the time of writing, the Magnificent Seven have a combined market cap of around $15 trillion. Meanwhile, the S&P 500 has a market cap of around $44 trillion. So, the Magnificent Seven control over 30% of the index.

Some pessimistic analysts have raised the alarm on this trend:

• They say that this represents a concentration risk. The market breadth is too narrow. How can it be that only a tiny cluster of large-caps are holding up the entire market? This seems awfully dangerous, doesn’t it?

• Well, to get to the heart of the matter, I am taking a critical look at the situation. I am exploring whether a rotation from large-caps to small-caps might be a possibility…