ALPHA INSIGHTS: The Die Is Cast - December 2020
During the late Roman Republic of the 1st century, the river Rubicon marked the boundary between the Roman province of Cisalpine Gaul to the north-east and Italy proper to the south. Governors of the Roman provinces were appointed promagistrates with imperium, or the “right to command” in the province which they ruled, effectively making them generals of the Roman army. Roman law specified that only the elected magistrates could hold imperium within the boundaries of Italy. Therefore, any Roman general who entered Italy at the head of his troops forfeited his imperium, and was therefore no longer legally allowed to command his troops.
Exercising imperium when forbidden by law was a capital offense. Furthermore, obeying commands of a general who did not legally possess imperium was a capital offense. If a general entered Italy in command of an army, both the general and his soldiers were considered outlaws and automatically condemned to death. Thus, generals were obliged to disband their armies before entering Italy. Any failure to comply with this law was considered insurrection, treason, and a declaration of war on the Roman Senate.
After nearly a decade of successful military campaigns, which became known as the Gallic Wars – resulting the conquest of Gaul, Gaius Julius Caesar, then the appointed Governor of the region extending from Gaul to Illyricum, had become one of the most successful and beloved Roman generals in history. But his growing popularity made some in the legislative establishment nervous. As such, Caesar was ordered by the Roman Senate to disband his army and return to Rome. He was explicitly ordered not take his army across the northern border of Italy – the Rubicon.
On January 10th, in the year 49 BC, Caesar led the 13th Legion south across the Rubicon river on his way to Rome. In so doing, he deliberately broke the law of imperium, making armed conflict inevitable. The Roman historian Suetonius, chronicled the event depicting Caesar as undecided upon approaching the river, knowing full-well that it was the point of no return. According to Suetonius, as his army marched through the shallow river, Caesar uttered the now famous Latin phrase, “alea iacta est.” Translation: The die is cast.
A similar conflict appears to be evolving in the broad U.S. stock market. The establishment of mega-cap stocks that make up some 50% of the market cap of the Nasdaq 100 index are losing momentum as Congressional lawmakers, led by the House Judiciary Committee, the DOJ, and the FTC investigate the business practices of big tech companies. The anti-trust probe and attendant potential for new regulations has taken some of the wind out of the sails of the so-called FAANG stocks. Meanwhile, a cadre of new emerging growth stocks, joined by a broad array of small and mid-cap stocks best represented by the Russell 2000 index have taken up the mantle of leadership in recent weeks.
The chart above, a ratio of the Russell 2000 index to the Nasdaq 100 index, suggests this reversal of fortune may be sustainable. The upper panel of the chart illustrates a 15-year decline in the ratio (white), which bottomed in August. A 36-month exponential moving average (red) defines the downtrend in place since 2007. The lower panel illustrates the momentum of said decline as a measure of the ratio’s deviations in percentage terms above and below the moving average, which is represented as zero in the oscillator. As can be seen in the lower panel of the chart, momentum (white) has developed a certain structural clarity to it, whereby the highs and lows since 2007 are bounded by a parallel trend channel (red). As momentum tends to lead price, in many ways, this trend channel represents a Rubicon of its own for this ratio.
As the ratio has turned up from its August low, momentum has also reversed sharply higher, accelerating to the lower boundary of the trend channel. Like Caesar, upon reaching the banks of the Rubicon, it is as if the smid-cap leaders are undecided about whether or not to cross the line. This 14-year old trend line was once key support, but is now key resistance. In much the same way that Caesar’s crossing changed the course of history for Rome’s old established leadership, penetration by momentum above this key resistance line could mark the point of no return for the old established stock market leaders.
In our view, a monthly close above the lower boundary will confirm that the die is cast. A sustained shift in leadership from mega-cap to smid-cap stocks, thus broadening participation in the advance, is the paradigm shift that we have been awaiting to confirm that the new bull market in stocks is both legitimate and durable. Without it, the narrow advance that has been led by a handful of heavy-weight performance leaders will remain on thin ice. Our bottom-up work has identified a multitude of recent new buy signals on small and mid-cap leaders across a wide variety of industries, with the majority concentrated in cyclical sectors like industrials and materials. There has also been some increased evidence of greater participation by financials, and of course, technology remains very strong below the surface of the large-cap indexes.
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