Markets

(Chicago)

Small caps are looking strong, and seem likely to outperform large caps over the next year. Small caps have seen two decidedly positive trends over the last month—an outperformance relative to the S&P 500, and increasing breadth. From a technical perspective, those are both encouraging. On the fundamental front, small caps are starting to follow a well-trodden path to success. Historically, every period since 1990 in which the Russell 2000 has outperformed the S&P 500, spreads have been widening. Bond watchers will have noticed that Treasuries have risen 28-40 bp recently across different maturities. Since that rise in yields seems likely to continue because of the growing debt needs of the US government, small caps may be in for a good run.


FINSUM: We really like this logic. Small caps tend to have a higher beta to GDP, so rising yields (hopefully indicating a better economic environment) should create additional spread widening, and thus be positive and create some continued outperformance.

(New York)

Investors are increasingly betting on a blue wave. More interestingly, the market’s calculus for what that blue wave to could mean to stock prices and the economy is changing. For much of this election cycle, a sweep by the Democrats was seen as a negative for the economy versus the status quo. However, in recent weeks investors have been shifting the other way—seeing a blue wave as a win for the economy. The reason why has to do with infrastructure spending and bigger and longer-term stimulus packages. While the possibility for this has been hurting Treasury prices because of the likely increased debt load, it also means that both infrastructure stocks and small caps seem poised to gain as we approach the election and well after it.


FINSUM: Small caps have just recently started to outperform their large cap cousins, a sign of the shift in perspective. Infrastructure stocks seem a good bet because no matter who wins the election there will probably be some deal on that front.

(New York)

Investors need to keep a very sharp eye on the bond market. The yield curve is steepening without any associated rise in economic activity. The reason why has to do with the election. Biden has been rising in the polls, and investors have been increasingly betting he will emerge victorious as part of a blue sweep. If that happens, it is assumed the US would issue a great deal more debt to fund stimulus packages. This means there would be significantly more Treasury bond supply than at present, and potentially calls into question the credit of the US government. As evidence of this trend, the spread between 5- and 30-year Treasuries just hit its largest since 2016.


FINSUM: This is a potential black swan event that no one has seen coming. The election seemed like it would be a dead heat through election day, but if the needle moves more towards Biden, the whole picture for fixed income will change.

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