Are Small Caps Inching Toward Another Spurt?

2020년 8월 4일

Growth stocks and the Nasdaq have outperformed for most of the market’s recovery over the last four months. This is consistent with the disciplined approach of sticking with winners and trying to avoid value traps.

However, there have been two periods that small caps showed relative strength: late April-early June and late May-early June. (See Smart RS on chart below.) Now some patterns on the iShares Russell 2000 ETF suggest it may be setting up for another run.

First, IWM jumped above its 200-day simple moving average (SMA) on July 15 and has stayed there since. It probed down below that line on Friday but was rejected – a false breakdown.

Next, IWM’s 50-day simple moving average has been inching higher from the downside. It’s about eight sessions (based on current speed) away from a “golden cross” through the 200-day SMA. That would be a classic bullish pattern.

Average True Range has also squeezed to its tightest level since the beginning of March, creating the potential for an expansion if it starts to move.

Finally, there are some broader, non-technical catalysts with the potential to help small caps:

1-Congress has yet to pass a stimulus bill. If one passes, it could help smaller companies with less focus on the tech sector. (IWM is less than 20% technology + communications, while SPY is 35% technology + communication. Remember “communication” includes Alphabet, Facebook, Netflix and video games.)
2-Economic data this week could show more rebound from the pandemic – especially payrolls from ADP (Wednesday) and the Labor Department (Friday). Yesterday’s manufacturing report was strong.
3-M&A: Dealmaking had a mini-comeback this week. A continuation of the trend could favor smaller companies that are potential targets.

In conclusion, sticking with relative strength can be a winning strategy. However, there are times when laggards play catch-up. Now could be one of those times, even if it’s brief.