Waverly Advisors On The Yawning Small-Cap, Large Cap Divergence

Weigh-in in on a hot topic, Waverly Advisors discusses the growing divergence between small and large cap stocks.

Yesterday’s session in US Equities had a generally positive tone, with most indexes closing up just under a per cent. Last week’s theme of weakness in small caps against resilient large caps has created a fairly significant divergence between the two groups (chart below). We think there are two conflicting messages to be read here. Of course, looking only at large cap blue chips gives an unrealistic assessment of the strength of the market. However, the continuing strength here (along with market-leading Energy and Industrials) is potentially frustrating to market participants anticipating a pullback.


We believe our current stance on equities is the most justifiable position from a perspective that focuses on risk management: most of our clients should be holding significant long exposure, ideally with an overweight tilt to domestic equities. However, it is difficult to justify being fully invested due to any number of technical factors we have outlined over the past week. We are somewhat concerned that the pullback has become consensus, and many market participants could be caught off guard if the market simply continues higher without a pullback. If this happens, we too will be caught without full exposure, but our first job is to manage the risk, which is significantly more than it was a few weeks ago. This is a tradeoff we will take every time, because, over a large sample size, these numbers work dramatically in our favour.

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