Growing market divergence could prove to be stocks’ 'Achilles heel'

Big tech has been driving the bull market, and one closely watched strategist argues it's creating an anomaly — one that could change investing strategies.

DataTrek Research's Nick Colas sees an atypical trend affecting the relationship between small cap stocks and large caps. He's calling it "one of the Achilles heels of indexing."

According to Colas, there's an assumption in the markets that all entities have about the same weightings. But in the case of the S&P 600 and the S&P 500, it's "dramatically different."

It all comes down to small caps not having enough tech exposure.

"The weighting in technology in the large caps in the S&P 500 is 25 percent. It's only 15 to 17 percent in the 600 and in the Russell," he said Monday on CNBC's "Trading Nation." "You don't have the same thing at all when it comes to performance. And, that's one reason why small caps have done relatively not as well this year as the large caps."

Looking at performance since January, both the S&P 600 and Russell 2000 are now lagging large caps by about 5 percent. Colas notes that historically, small-cap stocks beat large caps in bull markets like this one.

Colas, formerly Convergex's chief market strategist, devoted one of his new firm's recent daily newsletters to the trend.

"I've never seen so big of a divergence in my 30 years in investing," he said. "They do have technology, but even this year small cap tech is up 13 percent. Big cap tech up 32 percent. That gives you a sense of the disparity between these two kinds of indices."

He adds that when small-cap tech companies grow, they either get bought out or move into the S&P 500. So, investors don't get to own the name very long in its growth curve.

"Roughly 15 percent of the S&P 500 is in five names [Apple, Microsoft, Amazon, Facebook, Alphabet]," Colas said. "Those are global disruptor names. They really play out an entire theme around technology disrupting every kind of business around the world. ... The small caps don't have any of that kind of exposure."

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Trading Nation is a multimedia financial news program that shows investors and traders how to use the news of the day to their advantage. This is where experts from across the financial world – including macro strategists, technical analysts, stock-pickers, and traders who specialize in options, currencies, and fixed income – come together to find the best ways to capitalize on recent developments in the market. Trading Nation: Where headlines become opportunities.

Michael Santoli

Michael Santoli joined CNBC in October 2015 as a Senior Markets Commentator, based at the network's Global Headquarters in Englewood Cliffs, N.J.  Santoli brings his extensive markets expertise to CNBC's Business Day programming, with a regular appearance on CNBC's “Closing Bell (M-F, 3PM-5PM ET).   In addition, he contributes to CNBCand CNBC PRO, writing regular articles and creating original digital videos.

Previously, Santoli was a Senior Columnist at Yahoo Finance, where he wrote analysis and commentary on the stock market, corporate news and the economy. He also appeared on Yahoo Finance video programs, where he offered insights on the most important business stories of the day, and was a regular contributor to CNBC and other networks.

Follow Michael Santoli on Twitter @michaelsantoli

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