As I have argued previously for InvestorPlace, if stocks don’t crash, small-cap stocks and emerging markets stocks would likely be the biggest winners. Specifically, I wrote the following:
“Let’s say conditions do indeed favor credit spreads widening, as they have been doing recently, but an accident never comes. Let’s say the rally does persist into year-end, and the bulls are right. What’s the way to play it? Many would argue to just follow the playbook that’s already worked – large-cap tech stocks.
I disagree. If indeed markets were to continue to melt up and we get past the end of October, then I believe the play should be emerging markets and small-cap stocks on a return to breadth.
Why emerging markets? Because we are at a point now where the dollar’s strength, in the absence of a risk-off period, becomes harder and harder to justify. A turnaround in the dollar as risk-ON conditions return would help dollar-denominated assets overseas. Emerging market stocks would likely be beneficiaries of this.”
The move in small-cap stocks has clearly been playing out. When we look at the Russell 2000, the last 48 hours have been nothing short of breath-taking as a tremendous rush of money has gone into the very same “zombie companies” that lagged the “melt-up” this year on concerns of higher-for-longer rates.
If the move were to persist, I do think emerging markets stocks become the next momentum short-term beneficiary.
To be clear, as I noted on X and in The Lead-Lag Report itself, intermarket dynamics do not suggest this spike higher persists in the long term, and I very much maintain that investors are underappreciating the risk of “Phase 2” of the credit event.
But if there is more room to run into year-end, emerging market stocks could really be set to run. Why? Because if we are back to a more sustained risk-on environment AND the dollar were to fall further, it would be positive for foreign investments. Emerging market stocks tend to do well on a falling dollar, and, at least for now, the downtrend in the dollar seems to just be starting.
So, while I do think on a relative basis small-cap stock momentum can persist, a large rotation into emerging market stocks is a distinct possibility if indeed the short-term conditions persist in a positive way. And given just how poorly emerging markets have performed over the past decade, this seems like a good area to focus on.
On the date of publication, Michael Gayed did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
