Investors appear to be warming to small caps as the group is finally outperforming large caps, not just over the trailing week, but also the past month and quarter. Small-cap stocks have had a rough go at it over the past several years, particularly in relation to their large-cap peers in the S&P 500 which have returned roughly 34% off of last December’s lows. The Russell 2000 Small-Cap Index returned 30% over the same period. Here is a look at the performance of the major stock market indexes since their lows on Christmas Eve of last year.
While trailing by just 4% doesn’t sound significant, Small-Caps have been unable to make a new all-time high in 2019, unlike the major averages. While large-cap indexes have been making incremental new highs all year, the Russell 2000 is still more than 7% below its record high from August of 2018. But some recent technical developments in addition to the aforementioned relative strength give us reason to believe that new highs are on the horizon for small caps.
As shown in the chart above, the $159 level represents a critical level of interest which was successfully defended several times this year before recently giving way to buyers and becoming support. As we Technicians like to say, the more times a level is tested the more likely it is to break, and that is exactly what just happened with the Russell 2000 ETF, $IWM as prices finally resolved above key resistance before successfully retesting it from above.
This is textbook technical analysis and an excellent example of the Polarity Principle which according to Edwards & Magee, states that “critical price levels constantly switch their roles from Support to Resistance and from Resistance to Support.” The $159 area acted as resistance as prices failed here multiple times this year, but most recently it served as a successful support zone as prices reversed here following the minor selloff earlier this week.
The chart above shows the Volume At Price indicator on the Russell 2000 chart, illustrating a large cluster of activity in the $145 to $159 range. Above this level is a bit of a “No-Man’s Land” as there has been very little volume as prices only spent about a 4 month period during 2018 at such high prices. This tells us that there is very little price memory and therefore supply between current prices and all-time highs. When there is a lot of supply to work through in an area, such as that below $159, it can take bulls a good amount of time and capital to absorb and travel through it. The opposite is true in areas with little overhead supply. Therefore, the next 10 or so points could be a pretty smooth ride higher.
The Godfather of Technical Analysis, Ralph Acampora himself, commented on the positive price action from the Russell 2000 on Twitter this morning.
So far during today's sharp recovery rally, the Russell 2000 is actually registering a new 2019 high. Most other indexes are also coming very close to scoring new respective highs. Thus, this week's action, in sum, can be described as the long, over due, correction.
— Ralph Acampora CMT (@Ralph_Acampora) December 6, 2019
As Ralph points out, small caps continue to show relative strength as they bounced back to register a new 52-week high today after the brief selloff to start the week. This is in contrast to the major large-cap indexes which did not register new highs this week.
Also this week, CMT, Tom Bruni noted the relative strength from micro caps ($IWC) in a blog post titled “Small Stocks, Big Development?” where he discussed the ratio chart below and how it could be indicating a bottom in relative performance from smaller stocks relative to overall equities.
In addition to these bullish developments, we recently wrote an article about the seasonal tailwinds small-cap stocks typically experience in the winter months. The bottom line is if we continue in an environment where US Equities are trending higher, small-cap indexes like the Russell 2000 are likely to make all-time highs for the first time in almost 18 months as well as finally outperform their large-cap peers in the S&P 500 and Dow. It has been a number of years since investors could find positive alpha as they move down the market cap scale. The big guys have had a nice run but we think that is finally changing.