Battle Of The Weightings

Since October's lows, the RSP has been outperforming the SPY even though both of these ETFs contain the same stocks. As investors, let’s break down what this could tell us and how we could profit from this divergence. 

First, some definitions. An equal-weight ETF takes all the stocks in its holdings and buys an equal amount of each. So for the RSP to be the equivalent weight of all 500 names in the S&P 500, it would need each stock to represent 0.25% of its portfolio. Market cap refers to the size of the company in dollars. For example, Apple is worth $2.5 trillion dollars if you were to buy the company right now. This is its market cap. The cap-weighted ETF (SPY), adds more value to larger market-cap stocks. For example, AAPL and MSFT alone take up 10% of the ETF weighting since, combined, their size is considerable in comparison to the other 498 companies in the S&P 500.

As you can see from the chart above, the SPY (in pink) has been outperforming the RSP (in blue) since the 2020 lows and beyond. In a market like this, we know that the big guys are leading the charge. The big are getting bigger, and even if everything is going well, those large stocks drive the market. 

Let’s think like an RIA or fund manager for a moment. If most of the market performers you are benchmarked against are leading the market, you need to own those stocks or get the wrath of your investors. In a market cap-led market, you get everyone moving over to one side of the boat, with everyone moving into larger names. 

Since the market's October lows, this relationship has flipped. Now the equal-weighted index is outperforming the cap weight. This means that even though the bigger names are underperforming, we can still hold up and trend higher. 

The term we all heard before is “a stock pickers market,” which is precisely what the RSP vs SPY tells us. If you're stuck looking at the big names that killed it in 2020/2021, they are underperforming now. So broaden your search to the names now holding up the market. 

Reminder to all, the SPY is a relative strength actively managed ETF, not “passive investing.” If this trend continues, the “large names” might not be large names anymore, and the “small names” might just increase their market cap to become “larger names.” 

If you want to see what I am watching daily and how I am managing this new market, join me at www.statsedgetrading.com