In our Inside the Investment Committee presentation, I mentioned the great start to the year for high beta, domestic cyclical stocks (“high beta” refers to the volatility of the stock compared to the S&P 500). Small cap, semiconductors, miners, and energy stocks have more volatility when compared to the S&P 500 and therefore a higher beta. These areas tend to outperform when the economy is improving, which is why they’re called cyclical stocks — they ebb and flow with the economic cycle. This is exactly what we saw from the October bottom through January.
However, since January these areas have underperformed the S&P 500 as the price advances have been more concentrated in the large, lower beta stocks. From February 3, the S&P 500 is up 4.78% while two areas — small cap stocks and transportation stocks — have not been able to make any money (see the chart). This tells me that the market advance from the October low, which was an incredible 28% in just over 5 months, is due for a breather.
Additionally, transportation stocks are vital in Dow Theory to confirm the strength of the Dow Jones Industrials Index. Markets must move higher together to feel more confident that the market advance will continue. When the two averages diverge, it could spell trouble just ahead.
