I love it when bad news is actually good news.
Everyone is looking at a story one way... while under the surface, an entirely different tale is playing out.
This is the basis of contrarian investing. It's seeing the opportunity in the same set of facts that most folks use to assume the worst. And we've got one of those opportunities today.
Many believe that this setup will doom the current stock market boom. But history shows us otherwise. In fact, this misunderstood situation could lead to massive gains in a specific stock index.
Let me explain...
In a healthy rally, lots of stocks are rising. But the risk of a pullback increases when only a few of the largest stocks are driving the overall market higher.
We've seen the latter scenario in recent months. A handful of the biggest stocks have been soaring. Meanwhile, the rest of the market has been lagging.
To see it, we can compare the S&P 500 Index with its equal-weight counterpart. As you know, the regular index tracks the 500 largest stocks weighted by market cap. In the S&P 500 Equal Weight Index, though, they're equally weighted.
Right now, the five largest stocks make up around 24% of the S&P 500. But the same five stocks make up just 1% of the S&P 500 Equal Weight Index.
This difference has led to major outperformance in the S&P 500 over the past year. Take a look...
The normal S&P 500 is up 16% this year. On the other hand, the Equal Weight Index is up only 6%. That means the five largest stocks have been driving the rally. And this disconnect has also led to a rare situation...
Specifically, the difference between the trailing two-month returns of these indexes hit 6.2 percentage points earlier this year. This shows just how strong the outperformance is. Similar setups have only happened five other times since 1990.
This might sound like a bad omen for stocks. Most folks would expect tough times ahead when the market-weighted index crushes the Equal Weight Index. But the exact opposite happens.
It's not the big stocks that slow down... It's the smaller stocks that catch up. Take a look...
As you can see, the S&P 500 beat its typical return in the months after these setups. The market-weighted index jumped 6.6% in six months and 12.6% in a year. But the truly massive gains happened in the Equal Weight Index...
Similar instances led to 12.4% gains in six months and 26.8% gains over the following year. That's triple the typical return for each time period. Plus, the Equal Weight Index was higher in every case a year later.
Even more, the time frame I looked at includes the devastating market crashes that happened in October 2008 and March 2020... which were great times to buy. So these cases can precede fantastic long-term opportunities.
We have every reason to be bullish right now. This proves it once again... And it tells us that as the rest of the market catches up to the big players, an equal-weight exchange-traded fund like the Invesco S&P 500 Equal Weight Fund (RSP) is worth considering right now.
Good investing,
Brett Eversole
Further Reading
If you're still worried about the outperformance of large stocks, that's understandable. But history shows yet another reason why you should ignore the frightening headlines today... and why double-digit gains are likely. Read more here.
The S&P 500 is marching closer to a new all-time high. And with stocks now in an "official" bull market, it's likely to get there over the next year. That's because in times like these, stocks tend to keep soaring... Learn more here.
