Just to be clear and insure I don’t lose anyone just because of the title, this blog post is not about the rapper, Notorious B.I.G but instead, small cap stocks. While it is not a perfect indicator (but hey, what is?), watching what the small cap stocks are doing provides a very good insight into the stock market as it speaks to investor’s willingness to take risk. During times of optimism and market strength small cap stocks will outperform their bigger brethren. On the flip side when small caps are lagging that portends to a potentially bleaker outcome and investors should sit up and take notice.
Below is a chart of the US small cap stock index, IWM. In the upper pane is a momentum indicator RSI. In the middle is the price and the very bottom pane is the ratio of small cap stocks to the larger SP500 index. Since their first peak in the 1st quarter of last year (on their first touch of S1) you can see small cap stocks have been consolidating going nowhere for almost an entire year and under-performing the SP500. You can also notice at that time how far away price had gotten away from the blue uptrend line so a reversion to the mean back to that line should have been expected. The question as we consolidated was “is this just a normal, well deserved rest or something more?” For me, if price broke both S2 and the blue uptrend line that would have told us the answer to our question as it would have been an indication we were in for something much more. Instead, and right on queue price bounced exactly right off both support lines (red horizontal and blue uptrend) and we have not looked back since. Not surprisingly that "bounce" turned out to be the weekly low. Price eventually broke above S1, back tested it once and moved on to all-time highs. In the bottom pane you can see that since that weekly bottom print, small cap stocks have been on a tear outperforming the broader SP500 index by almost 10%.
While event and seasonality driven corrections are always on the radar especially in today’s crazy geopolitical environment, this is a very bullish sign and combined with follow through in the coming week would go a long way towards alleviating much of my concerns we have reached the end of this bull market … at least for now.
Have a wonderful Father's Day!