The Best Place for Tell Tale Signs: Small Caps?

The S&P 500 inched up a pitiful 0.03% last week. The Russell 2000 rallied 2.33%.

But that’s not the only reason small cap stocks are worth a second look right now.

As the weekly bar chart below shows, the Russell 2000 (NYSEArca: IWM) is bumping against significant double resistance.

The November 29 Profit Radar Report stated that: “Last week’s push higher happened during a holiday week on low volume, and therefore needs confirmation. RSI just barely failed to issue a bullish confirmation.

Small caps enter a bullish 1-month window (of relative outperformance compared to large caps) in mid-December. However, prior to catching this bullish seasonal tailwind, small caps will likely have to digest recent gains.”

This digestive period is now underway. Regardless of the immediate down side risk (which should be limited), the Russell 2000 sports the most pronounced overhead resistance.

A strong move above resistance may be the best tell tale sign of further gains. The Profit Radar Report will monitor the strength of any breakout to assess its longevity.

Simon Maierhofer is the publisher of the Profit Radar ReportThe 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

 

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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.

Small Caps – The December ‘No Guts No Glory’ Trade?

Historically, December is a good month to own small caps. However, the tendency for a nasty mid-month pullback is often overlooked. Will this correction send small caps even lower, or is it a good time to buy?

December has a reputation to be a good month for stocks, but that reputation is taking one on the chin as we speak.

In reality, December sports some seasonal ebbs and flows often ignored. Stocks tend to rally in the first part of the month, correct in the middle and finish strong.

Small caps in particular are subject to this up-down-up pattern. The December 7 Profit Radar Report referred to this tendency when it wrote that:

Small cap stocks tend to shine in December. History suggests we may see a pullback before the next surge. The green circles mark potential entry levels.

The updated Russell 2000 chart below includes the green circles mentioned in the December 7 PRR update.

The Russell 2000 in particular and stocks in general fell more than many expected, turning the potential year-end buy signal into a ‘no guts, no glory’ trade.

It certainly takes guts to push the buy button after this nasty sell off. Although seasonality suggests a favorable outcome for small cap buyers, it’s prudent to wait for technicals to confirm the initial stages of a reversal.

The iShares Russell 2000 ETF (NYSEArca: IWM) and Direxion Daily Small Cap Bull 3X ETF (NYSEArca: TNA) are two ways to play strong year-end small cap seasonality.

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 to get actionable ETF trade ideas delivered for free.

S&P 500: 3 Reasons to Expect the May Blues … But Not Yet

Have you been infected yet by the media’s crash talk? Most major financial media outlets predict a correction or outright crash. There are reasons to be worried about the ‘May Blues’ (sell in May and go away), but there’s also reason not to worry, yet.

According to CNBC, Dr. Doom is worried about a crisis bigger than 2008, and so should you.

There truly are reasons to expect some weakness (aka the ‘May Blues’), but perhaps just not yet.

Why Look for May Blues

1. Seasonality: S&P 500 seasonality for midterm election years is bearish. Click here for S&P 500 seasonality chart.

2. The Nasdaq-100 may be carving out a head-and shoulders pattern.

3. Stock market breadth is deteriorating. A truly rising tide lifts all boats, this rally isn’t. Large caps are in, small caps are out.

The chart below plots the S&P 500 (SNP: ^GSPC) against the IWM:IWB ratio. The IWM ETF represents the small cap Russell 2000, the IWB ETF represents the large cap Russell 1000.

The IWM:IWB ratio shows small caps quickly erasing an 11-months performance advantage.

Although this is a reflection of fragmentation, it should be said that, historically, this disparity does not foreshadow major immediate weakness.

Why Look for May Blues … Later

Simply because the media is looking for a crash right now.

CNBC: “I’m worried about a crisis bigger than 2008: Dr Doom”
MarketWatch: “Risk of 20% correction highest until October”
Investors Business Daily: “Why investors expect to ‘sell in May and go away’”
CNBC: “Wells Fargo strategist presents scary chart”

Based on various cycles, technical indicators and seasonal patterns, the Profit Radar Report proposed a May high back in January when it published the 2014 Forecast.

This outlook continues to be valid, however, it has now become the crowded trade.

The market will likely find a way to shake out the weak and premature bears, and fool the herd (the May 4 Profit Radar Report outlined the most likely route of this head fake).

In terms of technicals, the S&P 500 (NYSEArca: SPY) remains above important support and still within a chopping zone, obviously designed to hurt impatient investors. As long as this support holds, it’s dangerous to go short.

Even the weak Russell 2000 remains above an important support cluster (yes, more important than the 200-day SMA).

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.

Weekly ETF SPY: Russell 2000 ETF – IWM

Risk is rising when leaders turn into laggards. After outperforming the S&P 500 for years, the Russell 2000 failed to confirm the S&P’s new all-time high on April 10. The stock market in general peaked the next day. Here’s an updated look at the Russell 2000 and the Russell 2000 ETF.

We’ve been using the Russell 2000 Index as a ‘thermometer’ to see if the market is getting overheated. How can any one index work as a thermometer?

As rallies or bull markets mature, investors typically find fewer and fewer stocks at a price tag that justifies buying. Mature rallies are therefore accompanied by selective buying.

Selective buying is just a fancy expression for some indexes beginning to lag and underperform. High beta indexes, like small caps, are usually the first to be left in the dust.

That’s exactly what happened in early April, particularly on April 10. The S&P 500 rallied to new all-time highs. The Russell 2000 did not.

The April 10, Profit Radar Report pointed out just that: “The stock market has arrived at a point where selective buying is cautioning of a looming high. Upcoming resistance levels and divergence spreads (i.e. Nasdaq-100 compared to Nasdaq Composite, DJIA compared to DJA, and S&P 500 compared to Russell 2000) provide a low-risk opportunity to go short.”

In other words, there is a low-risk opportunity to go short as long as the Russell 2000 remains below its all-time high (recorded on March 15).

The purple bar in the chart below highlights the difference between the April 10 and March 15 highs, seven points. The risk of going short on April 11 was seven points. So far the Russell 2000 has fallen as much as 48 points. This is a risk/reward ratio of almost 7:1 in your favor.

On Thursday the Russell 2000 closed right above important triple support. Although RSI (bottom of chart) did not yet confirm the new price low, it failed to provide an obvious bullish RSI divergence. This suggests that any bounce at current support will lead to at least one more leg down.

A move below 890 should minimally lead to a test of 868, possibly lower.

The second chart shows the same support levels for the iShares Russell 2000 Index ETF (IWM). IWM already closed below the two ascending trend lines. Once price drops below support it turns into resistance (that’s why the trend lines are colored red).

IWM may foreshadow what’s next for the Russell 2000, but when it comes to trading/investing, I base my technical analysis on the purest representation of the respective asset. The purest representation of the Russell 2000 is the Russell 2000 Index, not the Russell 2000 ETF.

Nutshell summary for IWM: Based on trend line support for the Russell 2000 Index, small caps are likely to find support around current prices, but should ultimately move lower before embarking on a more sizeable rally again.

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April 12: GDX broke through support with a vengeance. A new low is likely before we’ll see a significant rally.

April 5: XRT closed below trend line support and registered a failed bullish percentR low-risk entry (lingo for: the up trend is likely broken). XRT is still trading above support at 68.70.

March 22: AAPL’s break above trend channel was a fake out break out. The March 31, Profit Radar Report stated that: “Apple failed to bounce from parallel channel support (on the log scale chart) and closed below. Our stop-loss was triggered and the option of much lower prices is now on the table. I’d like to see further confirmation, but the potential target for Apple may be as low as 353. Support at 425 – 405 could soften or halt the decline.”

March 15: XLF trades as high as 14.65, which was right in the 18.52 – 19.66 resistance cluster that was likely to halt XLF’s rally.

March 7: The Nasdaq-100 (corresponding ETF: QQQ) had two open chart gaps: 2,806 and 2,860. Although it seemed unlikely at the time, the Nasdaq-100 closed the gap at 2,860 on April 10 before declining well over 100 points.

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Will Small Caps Lead the Market to All-time Highs?

Market timers often watch small caps for clues about possible trend reversals, but thus far the Russell 2000 Small Cap Index is going strong. Here’s a closer look at seasonality and support/resistance levels for the Russell 2000.

It’s said that major market tops are often preceded by weakness in small cap stocks. This premise makes sense, as small cap stocks are most sensitive to the ebb and flow of liquidity. As a liquidity gauge, small cap indexes like the Russell 2000 could be the canary in the mine.

The truth is in the pudding. Does this theory hold up against the facts? The chart below plots the S&P 500 Index against the Russell 2000. I guess the key point is how you define a “major” market top.

Small cap weakness foreshadowed the 2007 top, but wasn’t obvious at the 2010, 2011, and 2012 highs (at least not on the weekly chart).

What about today? Small caps are going strong and the canary is chirping and frolicking.

The second chart provides a closer look at the Russell 2000 (corresponding ETF: iShares Russell 2000 ETF – IWM).

The Russell 2000 climbed back above the green trend line originating at the October 2011 low.

Recent prior peaks supply various resistance levels (red lines) and today’s decline drove prices below the green November 15 support line (an early warning signal), but starting in mid-December small caps tend to outperform large caps. January is one of the strongest months for small cap stocks.

Historical seasonal patterns suggest that more strength lies ahead for small caps. Technicals support this view. This may drive small caps to new all-time highs (less than 4% away), but I doubt it will be enough to push the Dow and S&P to all-time highs. A break below technical support at 836 (green trend line support) would warn that this year is different.


Simon Maierhofer shares his market analysis and points out high probability, low risk buy/sell recommendations via the Profit Radar Report. Click here for a free trial to Simon’s Profit Radar Report.