The small-cap stock rally is here to stay. Why these analysts say it’s bad news for the S&P 500

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The Dow just scraped a record high on Wednesday while other indexes fell, led down by the Russell 2000 — the key index of stocks with a small market capitalization.

But don’t think the little guys are giving up just yet.

Our call of the day is from the financial research specialists at Leuthold Group, led by Doug Ramsey, James Paulsen, and Scott Opsal. They say that “a long-term leadership cycle” in small-cap stocks is under way — and it may be bad news for big indexes.

The Russell 2000 RUT, -0.27% continues to register “ridiculously overbought” readings based on many technical factors, the researchers say, and that could be cause for market caution in the short-term. But the “extreme strength” of the index supports the Leuthold Group’s view that dominance in these stocks is here to stay.

Small-cap performance in January pushed the six-month total-return spread between the Russell 2000 and the S&P 500 SPX, -0.29% above 25% for just the eighth time since 1960. 

Now, here’s the kicker: In all of the seven past cases, it was only early or midway through a cycle where small-caps led stocks that the relative strength of the Russell 2000 breached the 25% mark. 

That means more is likely to come, but it may not be a healthy sign for the stock market overall. 

Since 1960, annualized returns for the S&P 500 were almost 6% lower when small-cap stocks have led. In fact, the researchers at Leuthold say that a portfolio of 50% cash and 50% small-caps could match the S&P 500’s volatility in the next few years while actually exceeding its return.

The backdrop of rising yields is also unlikely to derail this trajectory, the researchers say. Small-cap stocks have actually shown “a decisive performance edge” during recent periods when stock prices and bond yields moved in sync.

The buzz

Bumble went public in an initial public offering on the Nasdaq, with the shares priced at $43 each. The company’s popular namesake dating app requires women to make the first move.

It’s Thursday, and that means job reports on the economic front. 793,000 Americans filed initial jobless claims last week, above the median forecast of 760,000 but below 812,000 in the week prior. Continuing jobless claims in the week of Jan. 30 came in at 4.55 million, a decrease from 4.69 million in the week prior.

Shares in Canadian cannabis company Tilray TLRY, -42.04% rocketed 50% higher on Wednesday, rose 15% in the premarket, and have fallen more than 40% Thursday. Much of the cannabis sector behaved similarly. Tilray appears to be the latest heavily-shorted stock targeted by investors from the Reddit group WallStreetBets — the crowd behind the GameStop frenzy.

President Joe Biden held his first call with Chinese leader Xi Jinping. The White House said Biden pressed Xi on China’s “coercive and unfair economic practices,” as well as human rights issues in Xinjiang and anti-democracy crackdowns in Hong Kong.

Researchers have found that a diabetes treatment can tackle obesity. The drug in question led to 10% weight loss in most trial participants, and 20% in over a third. “This is the start of a new era,” one of the researchers said.  

Car maker Volkswagen VOW, +0.66% and software giant Microsoft MSFT, +0.02% are teaming up on an automated driving project.

Elon Musk’s younger brother, Kimbal, sold $25.6 million of electric-car maker Tesla’s TSLA, +0.50% stock.

The markets

Stock markets are slightly higher DJIA, -0.47% SPX, -0.29% COMP, -0.07% after the Dow was the only major index to record a gain on Wednesday. Markets are mostly subdued: Trading in China, Japan and South Korea has stopped for new-year celebrations. European markets SXXP, +0.46% UKX, +0.07% DAX, +0.77% PX1, -0.02% were mostly lifted on the back of positive earnings news.

The charts

Wolf Richter from the popular Wolf Street financial blog has our charts of the day. He compares global revenues against market capitalization for U.S. automobile makers General Motors GM, -3.30%, Ford F, -2.89%, and Tesla TSLA, +0.50%, following earnings reports from all three companies. 

Tesla stock represents what Richter calls “a class-act ludicrous-mode WTF moment” in markets. He points out that the stock gave up $78 billion in market value in the 11 trading days since Jan. 26 — more than GM’s entire market cap.

Random reads

“It’s pretty metal,” says a man who turned his uncle’s skeleton into a guitar.

An ancient hunter-gatherer conch shell sounds near-perfect notes after 17,000 years.

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