A Major Divergence Suggests Small Caps Could Really Pop

 Something very odd is happening between large and small caps in the stock market right now. And we believe it’s creating one of the best investment opportunities of the past 40 years. 

But time is of the essence here. 

You’ve probably heard by now that the large-cap S&P 500 has surged to all-time highs. In fact, as of this writing, it’s actually up more than 2% from its previous record highs in early 2022. 

But meanwhile, the small-cap Russell 2000  is basically still stuck in a bear market. As of Friday, Jan. 26, it was still down more than 20% from its record highs in late 2021. 

In other words, large caps are soaring to record highs while small caps are floundering. 

This has never happened before. 

In all of the stock market’s history, the S&P 500 has never been at all-time highs while the Russell 2000 was still in a bear market. 

However, we have seen similar situations play out before. And if stocks behave the way history suggests, prudent investors could bank some hefty profits.

Small Caps Will Snap Back

Three times in the past, the S&P 500 was at all-time highs while the Russell 2000 was in correction territory (down more than 10% from all-time highs). 

And all three times, small caps rallied furiously over the next year. 

Back in early 1985, the S&P 500 pushed to all-time highs while the Russell 2000 was still down 13% from its previous highs. Over the next year, the Russell 2000 rallied almost 20%. 

In early 1991, the S&P 500 pushed to all-time highs while the Russell 2000 was still down 14% from its previous highs. Over the next year, the Russell 2000 rallied as much as 36%.

Then in 1999 – the best analog to today’s situation, in our opinion – the S&P 500 pushed to all-time highs while the Russell 2000 was down 19% from its previous highs. And over the next year, the Russell 2000 rallied as much as 50%.

In other words, every time the S&P 500 has pushed to all-time highs while the Russell 2000 was still down big, small caps soared over the next year in a furious “snapback” rally. 

The bigger the divergence between the S&P 500 and Russell 2000, the bigger the snapback rally.

The Final Word

In 1985, the Russell 2000 was down 13%. It popped nearly 20% over the next year. 

In 1991, it was down 14% before it went on to pop almost 40% over the next year. 

And in 1999, it was down 19%, then soared more than 50% over the next year. 

Right now, we’re staring at these indices’ biggest divergence in history. 

The evidence suggests that means we’re also potentially staring at the biggest small-cap “snapback” rally of all time. 

(adapted from Luke Lango)