Series
What is this indicator?
The RSP/SPY ratio is a “lie detector” for the stock market. It tells you if the actual economy is doing well, or if just five tech bros in California are having a good year.
General Idea
This indicator compares two ways of owning the S&P 500:
-
Cap-Weight (SPY): The standard index. The bigger the company, the larger the slice of the pie. Apple and Microsoft alone might make up 13-14% of the fund. It is a “winner-take-all” strategy.
-
Equal-Weight (RSP): Every company gets the same slice (~0.2%). Apple gets the same influence as a random plumbing supply company in the bottom 500. It is a “participation trophy” strategy.
When you divide the price of RSP by SPY, you get a line chart that shows the battle between the “Average Stock” and the “Mega-Caps.”
What Does It Tell?
-
Ratio Rising (RSP > SPY): The “generals” (Mega-caps) and the “soldiers” (average stocks) are advancing together, or the soldiers are leading. This is a healthy, broad rally.
-
Ratio Falling (SPY > RSP): The generals are charging, but the soldiers are retreating. The market is being propped up by a few giants while the average stock suffers. This often signals hidden weakness or a mania in big tech.
SPY is heavily tilted toward Tech and Communication Services. RSP effectively tilts toward Industrials, Financials, and Utilities. A rising ratio often signals a rotation from “Growth” to “Value.”
Limitations
-
Rebalancing Drag: RSP is forced to sell winners and buy losers every quarter to maintain equal weight. In a powerful momentum market (like the AI boom), this kills your gains because you are constantly selling the best performers to buy the worst ones.
-
Not a Timing Tool: The ratio can trend down for years (e.g., 2010s Tech dominance). Betting on a reversal just because the line looks “too low” is a widow-maker trade.
-
Volatility: Counter-intuitively, RSP is usually riskier. By reducing exposure to the cash-rich giants (Microsoft/Apple) and increasing exposure to 400+ smaller, more debt-heavy companies, you actually increase your portfolio’s volatility.
Common Pitfalls
-
The “Diversification” Trap: You think RSP is “safer” because it’s more diversified. It isn’t. It is just a bet on the Size Factor (Mid-cap vs Mega-cap). If the economy tanks, the smaller companies in RSP usually fall harder than the giants in SPY.
-
Ignoring Sector Skew: If you use RSP/SPY to time the market, you might just be timing the Tech sector. If Tech crashes, the ratio spikes up—not because the economy is good, but because SPY is imploding.
-
Assuming Mean Reversion: Many smart investors lost money assuming the “gap” between RSP and SPY must close. Markets can remain irrational (and concentrated) longer than you can remain solvent.