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Small-Caps Are Showing Separation – Again

25 October 2013 in Trading Ideas

As investors watch the S&P 500 continue its climb toward another new round-number all-time high of 1800, it’s easy to forget that it’s the smaller fry that have been, on average, the year’s best catch.

The benchmark measure of small-caps – Russell 2000 – has increased 31.7% in 2013, while the large-cap S&P 500 index has risen 22.4%.

The Small-Cap Stars motif is up 24.0% since its inception on March 7, and has grown 4.1% in the past month. (The S&P 500 has gained 15.6% since March 7, 2013, and 3.7% in the last month.)

Whether you credit the Fed for holding off on tapering its asset purchases or signs that the housing market and consumer behavior is bouncing back, investors’ “risk-on” mindset appears to be the default setting.

What’s more the outperformance between small-caps and large-caps has widened in the past two weeks, with the Russell 2000 having gained 7.2% and the S&P 500 increasing 5.8%.

And, as Tomi Kilgore pointed out earlier this month in the Wall Street Journal, many stock market technicians tend to consider the performance of small-caps stocks as a proxy for investors’ risk sentiment.1

That’s because smaller-cap stocks tend to be less liquid than larger caps, which tends to see them rise faster during uptrends, and fall faster during downtrends, than does, for example the highly-liquid large-cap stocks contained within the S&P 500.

“When you look at the leadership in small caps, so far it’s still working, and now it’s accelerating,” Robert Sluymer, managing director of U.S. technical research at RBC Capital Markets, told the Journal on October 1.

And here we are again, with a similar accelerating outperformance, which makes Sluymer’s other comment from three weeks ago potentially instructive: “If a broader market correction was developing, we would expect to see more rotation away from small-caps. I’m sticking with the leadership message until we see some decay.”

One could anticipate many small-cap stock investors intending to do the same.

1Tomi Kilgore, “Russell 2000’s Record Points to S&P Breakout, Too,” WSJ.com, Oct. 1, 2013.