The S&P 500's sideways drift is masking a deeply divided stock market into the home stretch

Published Sat, Nov 20 20217:54 AM EST

The past two weeks have been a snooze for index investors, a dream for chasers of the trendy big growth stocks and something of a nightmare for owners of riskier cyclical plays. On a top-down basis, the sideways drift of the S & P 500 over the past couple of weeks — it closed at 4697.53 on Nov. 5 and at 4697.96 on Friday, with a less-than-2% dip and unhurried recovery in between — is exactly the sort of cooling-off process that looked necessary if the market was to avoid an unstable overheated melt-up, as noted here at the time . Yet for a dead-flat couple of weeks for the S & P 500 , plenty has gone on to cleave the market into adored winners and abhorred losers and to trigger yet another round of debate over whether a narrowing market is inherently a sign of emerging weakness or merely a healthy homeostatic rotation to absorb profit-taking and register new macroeconomic doubts. Friday's "risk-off" tone featuring slipping global bond yields and underperformance of cyclical stocks pretty neatly proceeded from news that Austria was re-initiating lockdowns to fight a new Covid wave. But this wasn't one day's business. In the two weeks of a flat S & P, the Russell 2000 small-cap gauge fell nearly 5% while oil-exploration and travel-and-leisure stocks lost about 10% as a group. The offset has come from mega-cap growth stalwarts, up nicely over the same span to hold the passive indexing crowd harmless. This is a routine that's become familiar. There have been three separate "reopening rally" phases this year, peaking in March, June and then early this month, each time rolling over and ceding leadership to more defensive tech names. There's more going on right now than a simple moderation of global economic enthusiasm, though. At the same time, investors have lost patience with once-beloved subset of expensive, trendy stocks with yet-unproven business models. The Roundhill Sports Betting and iGaming ETF (BETZ) is off 10% in the past two weeks and 18% from its peak, while the Global X FinTech fund (FINX) shed 8% in less than a month. Roku has been cut in half since late July and Uber has sunk some 30% since early March. All of these areas built up big valuation premiums, trading at high story-to-substance ratios, given credit by the Street for tapping vast total addressable markets but with questions over whether they could scale up quickly enough to justify investors' zeal. 'Cult of the new' This isn't so much a complete disillusionment with open-ended early-stage growth stories as a funneling of adrenaline-fueled enthusiasm into electric vehicle and "metaverse" plays almost exclusively. EV startups Rivian and Lucid Motors and interactive-gaming platform Roblox together have more than $275 billion in market value. Rivian and Lucid are essentially "pre-revenue" businesses and Roblox might hit $3 billion in sales this year. There is a certain "cult of the new" at large the market, with an unusually hefty proportion of stocks having arrived this year. As CNBC's Leslie Picker reported this week, the total value of IPOs exceeded $1 trillion so far this year, measured from offering price. That means roughly 2% of the U.S. public equity market has been on the board for less than 11 months – exciting and untested at once. Against this generous underwriting of novelty is an "out with the old" impulse to ditch losing stocks for portfolio-grooming and tax purposes. The hefty gains built up across the stock market (let alone in crypto) in the first ten months of the year mean an urgency to harvest losses to offset capital-gains-tax liability. This helps explain some of the downside momentum in faltering stocks and perhaps the undertow in the small-cap indexes that prevented the Russell 2000 from notching a decisive upside breakout this month. Wolfe Research maintains an index of tax-loss selling candidates, those down at least 15% year to date or 15% below their 12-month volume-weighted average price. The basket has been underperforming badly this month, and the loss-collecting pressure often lasts into December. In fact, it's the abatement of this selling activity that historically has helped drive the typical "January effect" outperformance of small-cap and lower-quality stocks. Following the bull-market script So where does all this leave the market with a month-and-a-half left in the year, crosscurrents of mechanical tax-driven selling interacting with the still-aggressive chasing of speculative call options in the high-momentum Nasdaq 100 names, while the economic growth trajectory gets redrawn in yet another rotation from the recovery to the reliability theme? Nothing that's gone on the past couple of weeks has deviated from the general fourth-quarter bull-market script. The typical year sees a lull or dip in the rally from early November into Thanksgiving week. Though Bespoke Investment Group points out that while strong years tend to finish strong, years when the S & P 500 is up at least 20% by Thanksgiving week have performed no better than average from that point through year end (up two-thirds of the time and average S & P return of 2%). While the rally has wobbled, various measures of investor sentiment and positioning still show a fairly aggressive posture, the year-end fear of missing further gains at work. Often, optimistic sentiment doesn't work well as a contrarian indicator near year's end, sometimes deferring its signal into the new year The weekly National Association of Active Investment Managers equity-exposure gauge was above 100% long stocks for the third straight week, something that last happened in December 2020. The S & P had late-January shakeout and was choppy into March 2021, but nothing that derailed the sturdy uptrend. The market's rotational choreography won't always be as flawless as it's been this year and we are now facing decelerating earnings growth and a Federal Reserve under pressure to move more quickly against inflation. But who's to say there can't be another tidy handoff soon, with an overbought Nasdaq settling back and bedraggled recovery proxies rediscovered by the fast money? It's always worth a reminder that this is an odd and accelerated market cycle, the magnitude of gains off the lows and the compressed economic snapback bringing mid- or late-cycle considerations into view: Fed-tightening guessing games, possibly peaking profit margins and the like. Deutsche Bank's late-cycle stock basket has in fact nosed ahead of the early-cycle gauge on a year-to-date basis. No market-timing indicator is perfectly prescient and "late" doesn't mean "nearly over," but something to consider all the same.

Traders work on the floor of the New York Stock Exchange on Nov. 5, 2021.

Spencer Platt | Getty Images

The past two weeks have been a snooze for index investors, a dream for chasers of the trendy big growth stocks and something of a nightmare for owners of riskier cyclical plays.