Small Caps Lead Market – Good or Bad Omen?

The Russell 2000 index of small cap stocks just pushed to new all-time highs.

Is this bullish for stocks?

To find out, I’ve plotted the S&P 500 against the IWM:IWB (small cap/large cap) ratio.

IWM is the iShares Russell 2000 ETF (NYSEarca: IWM). IWB is the iShares Russell 1000 ETF (NYSEArca: IWB).

Based on the ratio (currently at 1.06), the recent outperformance is by no means extreme.

What if we pretend for a moment that small cap outperformance was extreme (reading of 1.10 or greater)?

The red lines mark prior periods of small cap outperformance (IWM:IWB > 1.10). The S&P 500 (NYSEArca: SPY) couldn’t care less.

If anything, one could make an argument that extreme small cap underperformance works as buy signal. The dashed gray lines highlight readings smaller than 1.03.

 

The gray overlay of the iShares Russell 2000 Small Cap ETF (IWM), makes it clear that IWM is only trading 3% above where it was a year ago. The S&P 500 gained 13% since March 2014.

Small caps are often portrayed to be the engine that pulls the train (or at least the canary in the mine), but that’s not true.

We dispelled this myth in July when many jumped on the ‘small caps are down, the market’s going to crash’ bandwagon.

Perhaps recent small cap outperformance is a reflection of the idea that a strong dollar hurts multi-national large caps with overseas income more than small domestic companies.

But what happens if dollar strength takes a breather?

One more thought: Historically, small caps tend to under perform in the later stages of a bull market.

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013 and 17.59% in 2014.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

This Bearish Russell 2000 Pattern is Still Alive

The Russell 2000 has been taking it on the chin: It’s been the scapegoat for the April sell off and, unlike other indexes, wasn’t able to report new all-time highs in June. Will the Russell 2000 catch up or lead the broad indexes lower?

The Russell 2000 has been the ‘black sheep’ and ‘scapegoat’ of market indexes. Small cap stocks led the April sell, losing as much as 10%, and lagged the May/June rally.

What’s the deal with small caps? Will they catch up or lead the broad market lower?

Here’s what the Russell 2000 (Chicago Options: ^RUT) chart says:

Support

On May 6, the Russell 2000 closed below the 200-day SMA for the first time since November 21, 2012.

The May 7 Profit Radar Report made this observation: “Many investors follow the 200-day SMA. A close below it is generally considered a sell signal and/or bear market. The path of least resistance would be to jump on the sell signal bandwagon, but that’s premature in my humble opinion. The Russell support cluster at 1,100 – 1,080 seems more important than the 200-day SMA at 1,115.”

The small cap/large cap ratio (IWM/IWB) chart IWM = iShares Russell 2000 ETF (NYSEArca: IWM), IWM = iShares Russell 1000 ETF (NYSEArca: IWB) – featured in the same Profit Radar Report also suggested that important support is still ahead (chart below).

Here is an updated version of the IWM:IWB ratio chart plotted against the S&P 500 (NYSEArca: SPY). Green trend line support held and buoyed small caps and the S&P 500.

Resistance

1,080 is also the neckline of a possible head-and shoulders pattern. The May 11 Profit Radar Report stated that: “The Russell 2000 has kept the possibility of a bearish head-and shoulders pattern alive, as the left and right shoulder sport near-perfect symmetry. The ascending red trend line at 1,188 appears to be the dividing line between bullish and bearish bets.”

Summary

For now the Russell 2000 is trading between support and resistance. The weak IWM:IWB ratio recovery hints at further small cap weakness, but for now there are different ways to play this constellation:

  • Sell against resistance
  • Buy against support
  • Buy once resistance is busted
  • Sell once support is broken

Perhaps even more revealing is the current S&P 500 constellation. The 2014 S&P 500 forecast projected an S&P 500 high around 1,955 in May 2014.

The S&P 500 reached this target in June and peeled back. Does this mean a significant top is near? All the details are available in an update to the original 2014 S&P 500 forecast:

Updated 2014 S&P 500 Forecast

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

How Bad is Small Cap Underperformance for the Broad Stock Market?

The small cap sector has lost as much as 10% while the Dow Jones and S&P 500 are still within 1% of their all-time high. This chart illustrates the discrepancy better than any other. How bad is this for the broad stock market?

Small cap stocks have been taking it on the chin. The Russell 2000 lost as much as 9.85%. How bad is small caps’ performance relative to large caps?

Bad! Here’s a look at the small cap:large cap ratio (published in yesterday’s Profit Radar Report). The chart below shows the ratio between the iShares Russell 2000 ETF (NYSEArca: IWM) and the iShares Russell 1000 ETF (NYSEArca: IWB).

Small caps erased an 11-month performance edge in less than 6 weeks. The last time the IWM:IWB dropped as far was from July – October 2011.

The second chart plots the S&P 500 (SNP: ^GSPC) against the IWM:IWB ratio. The July – October 2011 small cap underperformance (big IWM:IWB drop) was a coordinated decline that saw large and small caps decline at the same time.

Small caps just fell much harder than the S&P 500.

This time is different. Small caps are down significantly while large caps (S&P 500 and Dow Jones) remain within 1.5% of their all-time highs.

At the same time, the Russell 2000 closed below the 200-day SMA for the first time since November 21, 2012.

However, this may be more of a bear trap than a sell signal. There is a must hold support area that’s more important (because not as obvious) and less prone to false signals than the 200-day SMA.

Must hold support is outlined in yesterday’s Profit Radar Report.

Personally, I feel that there’s been too much bearish media coverage for stocks to enter an immediate, prolonged correction (must hold support will tell me when I’m wrong), so I’m also looking at key resistance. The kind of resistance that should U-turn a bounce.

Must hold support is discussed in yesterday’s Profit Radar Report. Key resistance is revealed here:

The Secret Dow Jones Barrier Every Investor Should Know

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.