Market indexes are at all-time highs — except this one. What this means for stocks.

The Russell 2000 has not hit a new high in nearly four years, remaining 8% below its November 2021 peak, a significant divergence from the record-setting S&P 500. While this long-term gap is the longest on record and might typically signal market weakness, experts argue that only short-term divergences (1-3 months) are predictive of major market tops. Crucially, the Russell 2000 has recently shown strong performance, gaining 18.7% over the past three months and outperforming the S&P 500, suggesting that current conditions do not indicate an imminent market top.

Analysis

A significant performance divergence has emerged in the U.S. equity market, with the Russell 2000 index remaining approximately 8.0% below its November 2021 all-time high, marking the longest period on record that the small-cap benchmark has lagged while the S&P 500 achieves new records. While such a divergence can signal market weakness, recalling the three-month lag that preceded the 2007 market top, analyst research cited in the article suggests that only short-term divergences over a one-to-three-month period are reliable predictors of a major market peak. Multi-year divergences, like the one currently observed, are considered to have little market-timing significance. The current market situation is viewed more favorably, as there is no evidence of a short-term divergence. In fact, over the past three months, the Russell 2000 has demonstrated superior strength, gaining 18.7% compared to the S&P 500's 18.2% gain. This recent momentum, combined with the index approaching its first 'golden cross' in 18 months, supports the assessment that a major market top is not imminent.

Key Decisions for Investors

• Investors should prioritize recent relative strength between small and large caps, as the analysis indicates that short-term performance over a 1-3 month period is a more reliable indicator of market health than the multi-year divergence.
• Given the Russell 2000's recent outperformance and positive technical signals like the approaching 'golden cross', it may be prudent to re-evaluate underweight positions in small-cap equities for a potential catch-up rally.
• A key risk to monitor is the emergence of a new short-term divergence; renewed weakness in the Russell 2000 relative to the S&P 500 over a 1-3 month period would serve as a primary warning sign for a potential market top.