The Factor Rotation Isn’t About The Fed

We don’t usually comment on near term stock market performance, but sometimes it’s worth mentioning if the action is truly extreme. Last week was an extreme situation. After the Fed decision, the growth stocks as measured by the ARKK innovation ETF tanked. Then from late in the day on Thursday through Friday, the ARKK stocks exploded and the small cap value stocks imploded. Specifically, from Thursday afternoon’s low to Friday’s close, the ARRK ETF rose 5.3%. The small cap value Russell 2000 index fell 5.8% on the week. This was partially driven by small cap banks as the KBW index fell 7.2% on the week. Friday’s trading session was hugely impacted by triple witching (options expiration) which certainly confused things.

Our hypothesis is that the Fed doesn’t have much to do with the recent crazy trading action. It’s more about a potential peak in economic growth and inflation. Of course, the move was probably overdone though. Plus, when the quant/macro traders start dominating the market, they do so inefficiently. The baby has been thrown out with the bathwater. Not every industrial company should have their stock sell off 10% because economic growth will slow. In fact, growth might still be solid after the peak.

This crazy trading action created a new record. The chart above shows the S&P 500 had the highest percentage of firms at a one month low while the S&P 500 was within 1% of its record high. If you owned a basket of stocks that excludes the mega cap tech giants and the innovation names, you probably had a very bad weak.

It’s common for investors buying individual names to lag the index in selloffs, but this was unprecedented. This barely registered as a selloff for the overall market, yet many portfolios were down over 5% from their peaks earlier in June. Cyclical value stocks had a terrible week. When the mega cap stocks do well, it usually causes some sort of record because the market is so top heavy. This is just another example of that.

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