Is it Time for Small Caps to Lead?

US Small cap stocks (IWM) have been underperforming their bigger brethren (SP500) for more than a year, lagging by more than 15% over this period. Looking at the ratio chart (middle pane) of US small cap stocks to US large caps below, you can see we are at a potential inflection area. When the line is rising, small caps are outperforming and when falling they underperform. Over the past 15+ years each time the ratio reached this level, small cap stocks bottomed and went on to outperform. Additionally, you should also notice in the bottom pane of IWM price, each touch of that level resulted in a very significant, long run higher for the index. When combined with the positive RSI momentum (top pane), signaling a potential upcoming trend reversal, small cap stocks are back on the watch list.

fiduciary san ramon napfa cfp investment advisor iwm-spy 7-17-19.png

Currently clients have zero exposure to the small cap sector since there has been no reason to own them due to their underperformance. But, when looking at the weight of the evidence if we get a trend reversal in the ratio, a breakout of the current consolidation on larger (institutional) buying, it seems like the right time to be adding a starter position into the index.