Is It Time To Rotate Into Small Cap Stocks?

Is It Time To Rotate Into Small Cap Stocks?

In 2017, the small-cap iShares Russell 2000 ETF (IWM) was up 14.60%, following a 21.60% gain in 2016. By comparison, the Spyder Trust (SPY) was up 21.6% in 2017, as the large caps outperformed the small caps by 7 percentage points for the year. However, in 2016, SPY was only up 12% for the year, an increase that was 9.6 percentage points less than the gains in IWM.

Many analysts, myself included, thought the small caps might do better in 2018, but as of Tuesday’s close, the SPY is up 1.7%, while the IWM is down 1.38%. However, a look at the charts this week indicates that now might be the time to rotate into small-cap stocks.

During the bull market from late 2002 through 2007, the small-cap Russell 2000 led the S&P 500 by a wide margin. At the July 13, 2007 high, the Russell 2000 was up 148%, while the S&P 500 was up 85.8%. This is a difference of 62.2 percentage points from the October 2002 low.  The chart also reveals that corrections during the bull market were much sharper in the small cap Russell 2000.

For example, during the correction in early 2005 (point 1), the Russell 2000 dropped 21%, while the S&P 500 just lost 11%.  The disparity was even more pronounced during the decline from May-July 2006 (point 2), where the Russell 2000 declined 32.5%, but the S&P 500 was just down 11%.

In July 2007, both the S&P 500 and the Russell 2000 made new highs, followed by another correction. After that correction, the S&P 500 made a new high in October, while the Russell 2000 failed to reach its high from July. While the chart support in the Russell (line a) was broken in November 2007, the corresponding support in the S&P 500 (line b) was not broken until January of 2008.

So what about the current situation? Since the February 9th low, the Spyder Trust (SPY), which is based on the S&P 500, is up 7.3%, while the IWM is up 9.1%. The difference in performance was most pronounced last Friday, when the IWM closed up 1.5%, but the SPY was up just 0.51%.


The weekly chart of the iShares Russell 2000 (IWM) shows a well-defined trading channel (lines a & b). The IWM dropped below the lower boundary in early February, but it did not close below it.  The key level of resistance currently is at $160.62, which was the January high. Once this level is exceeded, resistance is at the weekly starc+ band at $162.65, and then the upper boundary of the trading channel at $167.77.

Below the chart is the relative performance (in red) with a 21-period weighted moving average (WMA) in green.  The relative performance (RS) measures the performance of an ETF or stock against the S&P 500. My relative performance analysis relies on using chart analysis on the indicator. The relative performance (RS) moved above its WMA last week, a positive sign.

Stocks or ETFs that are outperforming the SPY or S&P 500 will generally rise more when the market is rising. They are also likely to decline less than the SPY in a falling market. Those ETFs that are rising but have a negative slope in their RS are very likely to underperform the market. The RS analysis plays a key role in my recommendations of ETFs and stocks.

The weekly RS for IWM now needs to move above its resistance (line c) to confirm that IWM has started to lead the SPY.  It is possible that this will happen before IWM makes a new high, as the RS analysis often leads prices. The IWM now has initial weekly support at $148 and it would take a weekly close below the year’s low at $142.50 to turn the chart negative.

The daily chart of IWM shows that on Tuesday, IWM closed on the high, as it was up over 1% while the SPY was up just 0.2%. The daily RS had tested good support (line b) again last week. With Tuesday’s close, the RS has moved above its downtrend (line a) completing the bottom formation.

In using the relative performance to select stocks and ETFs for my clients, I have found that in about 80% of the instances, the bottom formations in the daily RS analysis are later confirmed by the weekly RS analysis. This gives me some confidence that IWM's weekly RS will soon also confirm that the small-cap stocks are leading the S&P.

Here are some other small cap ETFs you might take a look at:

  • iShares Core S&P Small-Cap ETF (IJR)
  • Vanguard Small-Cap ETF (VB)
  • Schwab U.S. Small-Cap ETF (SCHA)
  • SPDR Portfolio Small Cap ETF (SPSM)

If you are interested in following my style of analysis I hope you will consider the Viper ETF or Viper Hot Stocks reports.  Specific recommendations are sent out twice each week and each report is only $34.95 per month.

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