Charts of the Week: Continued Positive Signals for Equal-Weighted Indices

Last week’s small cap rally is a rare occurrence but doesn’t carry strong historical odds. Big up moves (especially on relative) happen almost as often in sustained relative downtrends. That said, there are plenty of signals in my work that suggest a positive backdrop for small, mid, and equal weighted indices.

The increasing odds of a Fed cut has historically provided a boost. And while much has been written about small’s increasing rate sensitivity, it is important to remember they’re both rate and growth sensitive. The nascent equal weighted earnings growth acceleration is critical and increases odds of a positive backdrop.

Starting points matter. For the first time in over 20 years the valuation gap between cap weighted and equal-weighted indices hit the top quartile. This alone improves equal-weighted’s outperformance odds but falling interest rate have added substantial fuel to that fire. Rates don’t operate the way you might think – lower rates don’t consistently improve future fundamentals.

The most consistent impact has been on multiples – when rates fall, equal weighted multiples expand 10-20% more than large cap multiples, the opposite of what happens when rates rise. Fundamentals don’t change, just how much the market pays for them. Given Technology earnings growth is back to top quartile levels, the market is likely to broaden. It may come from areas of the market with anomalous set-ups just like this.

This information is provided for educational purposes only and is not a recommendation or an offer or solicitation to buy or sell any security or for any investment advisory service. The views expressed are as of the date indicated, based on the information available at that time, and may change based on market or other conditions. Opinions discussed are those of the individual contributor, are subject to change, and do not necessarily represent the views of Fidelity. Fidelity does not assume any duty to update any of the information.