Relative Strength In S&P 500 Equal Weight

Yesterday the S&P 500 concluded the trading session with a decline of 0.88%, despite nearly 80% of the companies within the index recording positive closes. Conversely, the S&P 500 Equal Weight Index exhibited a robust performance, closing up 1.21%. This notable outperformance of the equal-weighted index over the cap-weighted index has occurred only three times since 2004, typically aligning with periods of strong market activity.

In case that the economy demonstrates resilience and avert a near-term recession, historical trends suggest a continued outperformance of the equal-weighted index compared to the cap-weighted index over the forthcoming years.

This outlook is not only supported by historical data but also by current market fundamentals. Right now, the concentration within indexes is at unprecedented levels. The overall valuation of the S&P 500 appears elevated; however, excluding the Magnificent Seven (Mag 7), valuations revert to the average levels observed in recent years. Furthermore, while the earnings growth of the Mag 7 is decelerating, the earnings growth of the remaining companies is on the rise.

Additionally, recent inflation data falling below expectations, reinforcing the likelihood of Federal Reserve rate cuts, supports the catch-up of lagging stocks over the stronger performers. As seen recently, small-cap stocks have achieved the best relative performance versus the S&P 500 in history. If this scenario persists, we can anticipate continued upward momentum in the indices, accompanied by sectors and size rotations, as currently observed.

Let’s see what happens and if history repeats itself.