MDY SPDR S&P MIDCAP 400

For several months, I've been watching two indexes that I like to call "the other 2,400 stocks." One is the Russell 2000 Small Cap and the other is the S&P Mid Cap 400. Both indexes have continued to make new all-time highs since January 2.

RUT and MID, as I will refer to them hence, have actually been leading the broad market charge since November and this speaks well of two driving forces:

1) Economic optimism, both macro and micro, among analysts and portfolio managers

2) Market breadth, where "the other 2,400 stocks" destroy the notion that big-caps are alone driving the rally

Just for fun today, I wanted to see some long-term performance of RUT and MID versus the S&P. For your amazement, a couple of charts since 1997...

We are not really surprised to see small cap stocks individually outperform their big brethren. That's where the growth is after all as small companies who succeed tend to keep getting bigger. What's impressive to see is small caps as a group participate in a broad-based way even during this 12-year old secular bear market.

Now for the shocker. The MID has crushed the S&P by a factor of five-plus in the past 15 years!

RUT and MID Say Higher We Go

In November, I had a decent win with market timing while I was looking for the S&P to bounce off of the 1340 area. Instead of buying the SPY or 2X S&P Bull, SSO, I dove into a 3X leveraged ETF on the RUT. Since then, TNA has returned 45% and 57% for me in two separate portfolios as the RUT has rallied from 765 to 895 (17%).

But I dropped the ball with the MID as I watched the breakout to new all-time highs above 1,030 and kept waiting for the pullback opportunity that never came. This is the nature of these kinds of rallies.

US equities have been under "multiple repression" as global and domestic political and financial worries have kept a lid on valuations. We've suffered three scares for three years for recessions than never came.

The valuation lid is coming off now.

Here's what I said on Friday when asked about my "confidence level" in this market, after the University of Michigan Consumer Sentiment survey disappointed with a low 70s read, another drop from 5-year highs near 80 in late Nov and mid-Dec...

I'm the same #1 (highly confident) I've been for weeks. So, still highly confident.

US economic fundamentals continue to improve = Tailwind.

US policy uncertainty almost over = Obstacle removed.

Europe stable = Contagion removed.

China ready to grow again = Tailwind restored.

Money managers are eager to capitalize on these conditions. That's why the Russell 2000 and MidCap 400 made new all-time highs even before the S&P got through 1470.

Yes, earnings estimates for 2013 are still too high and due to be revised lower. But if the economic data keeps improving, maybe they don't need to come down from 10% growth to 5% growth. $105 for the S&P seems very realistic and that would be another record year.

The other factor here is market sentiment when all these new conditions meet above S&P 1500 and bears and sideliners look around and say "Oh man... this is for real!"

The potential melt-up has only just begun.

My bumper sticker says "I Buy Dips!" because I see a 60% chance we see S&P 1600 before 1400.

Kevin Cook is a Senior Stock Strategist with Zacks.com
 
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