Wall Street's 'dash for trash' is heating up as small caps, unprofitable tech and other speculative bets rally

Even gold has been transformed from a conservative inflation hedge into a speculative instrument for betting on rate cuts, said Michael O’Rourke, chief market technician at JonesTrading.

A mad rush for small-cap stocks, shares of unprofitable technology companies and heavily-shorted names has revived talk of a “dash for trash” on Wall Street.

Talk of a migration from quality to “trash” has reemerged as investors begin to shun the S&P 500 SPX in favor of riskier, more speculative bets.

Many of these have continued to charge higher on Monday, even as the S&P 500 and other major U.S. equity indexes appeared to run out of steam, FactSet data showed.

One man’s trash…

“We’re seeing some really speculative moves,” O’Rourke said during a phone interview with MarketWatch on Monday.

Ultimately, strategists say the “dash for trash” trade is being driven by expectations that the Federal Reserve could cut interest rates as many as five times next year.

Rate cuts often benefit more speculative investments by forcing investors to reach for returns in riskier assets, as so-called defensive assets like bonds become less attractive.

To be sure, investors have seen this kind of dynamic before, even recently. The prospect of a “dash for trash” had been bandied about early last month, and in January as well, after being popularized during the 2021 meme-stock frenzy, which saw shares of troubled companies like AMC Entertainment Holdings AMC, +1.46% reap stratospheric gains.

Small-caps make a splash

Since late October, investors have rushed to bid up the small-cap Russell 2000, driving a stunning turnaround in an index that had been trading at historically cheap levels compared with the S&P 500 SPX and Nasdaq Composite COMP. The small-cap index has gained 14% since logging its 2023 closing low on Oct. 27, according to FactSet data. Over the same period, the S&P 500 is up 11.6%.

The Russell 2000 RUT rose 3% on Friday, handily beating the S&P 500, and continued to outperform on Monday, rising 0.6% in recent trade while the S&P 500 remained mired in the red.

The Ark Innovation ETF ARKK, a proxy for unprofitable technology companies, has also handily outperformed the S&P 500 and Nasdaq, having risen 5.4% since the beginning of Friday’s session. The ETF, which is managed by Cathie Wood’s ARK Invest, was up by nearly 1% on Monday to trade at $48.55 a share, as surging bitcoin prices helped boost shares of Coinbase Global COIN, +0.92%, one of the ETF’s top holdings. Shares of the cryptocurrency exchange were up more than 4% on Monday.

That Coinbase and other bitcoin-focused stocks are doing well is hardly a surprise, with bitcoin BTCUSD, -1.86% trading north of $41,000, a level it hasn’t visited since the spring of 2022, well before the collapse of FTX.

Gold has also found itself caught up in the dash-for-trash rally as futures surged to a record high north of $2,100 an ounce late Sunday, before pulling back in Monday trade.

But not everything that is rallying right now is purely a reflection of rate-cut hopes. Some are piling into long-shot bullish bets on shares of GameStop Corp. GME, -1.05% ahead of the company’s coming earnings report later this week, which often happens ahead of earnings reports for a company known as the original meme stock.

Shares of the videogame retailer have rallied 28.4% over the past five sessions, according to FactSet data. Strategists said the video-game retailer’s gains have been driven in part by a short squeeze, as the stock has maintained a high level of short interest.

Can the rotation continue?

Some, including Nicholas Colas, the co-founder of DataTrek Research, expect small-caps could see more upside ahead.

As Colas explained in a note to clients, lower rates should be a boon for smaller companies, especially the Russell 2000, since many companies included in the index are either consistently unprofitable or have spotty records of profitability.

Warning signs

“Usually, the dash for trash happens kind of late in the rally,” he said.

That was certainly true in 2021, as the gains in meme stocks and bitcoin were swiftly and brutally unwound during the 2022 selloff, helping to drive the S&P 500 to its biggest calendar-year drop since 2008, Dow Jones Market Data show.

O’Rourke doesn’t see such an obvious setup this time around.

“We’re now at the point where traders are chasing gold and bitcoin,” O’Rourke said. “But I can’t say for sure that we’re late in the rally.”

Obstacles to the rally abound in December. Investors will receive a monthly report on the labor market from the Labor Department later this week. Then next week, the Fed holds its December policy meeting. Both events could influence investors’ thinking about rate cuts, and could have profound consequences for markets.