One of the first things I learned as a market analyst is to keep your eyes on small cap stocks. They are usually the first out of the gate in a burgeoning bull market and the first to fall at the commencement of a bear market. As such, whether I am invested in them or not I watch closely for hints on expected future broader market behavior. As of right now while they have had a strong short term run, small caps have yet to confirm the broader market bull thesis by making new highs.
In the weekly chart below you can see the current price sits just below the prior high made in June of last year. As such and as of this instant we have formed not only one lower low but also one lower high. Additionally you can see the head and shoulders pattern that has developed at the same time negative divergence has formed on RSI momentum. If you are bullish this is not what you want to see. Looking to the left half of the chart you can see the last time this same set up occurred was in 2008 where the market subsequently dropped 60%. The target of this pattern if it were to play out is a slightly less gut-wrenching 50%.
With the charts warning of potential serious trouble is it time to sell everything, batten down the hatches and crawl into your fallout shelter? Probably not. A small 1% rise and hold will invalidate the topping pattern while further strength can easily wipe out the divergence. This market, for whatever reason, continues to defy gravity and ignores all fundamental reasoning. As such, it is likely the small caps, like many other sectors, corrected and are playing catch up to the broader market. If this is the case, and we will likely now in the few weeks, this is one more feather in the bulls cap and further confirmation the trend is up (until it isn’t) so don’t fight it.