Are Small-Cap Stocks Preparing to Rise From the Ashes?

September 21, 2020  |  Michael Reilly

Well, if history does indeed repeat itself, investors would be wise to keep an eye on Small-cap growth stocks.

Because while pundits continue to complain about how Large-cap tech stocks are the only leaders of this market, Small caps appear to be heating up.

Think of small caps like a volcano rumbling before a possible eruption. Is it just a few tremors, some smoke and noise? – or this the big one!

Is now the time that small caps take control of the market?

The technicals think so.

The beauty of technical analysis comes down to one thing – price.  And really, what else matters! Focus on what’s happening to priceNOW vs. prognosticating about what MIGHT happen later.

Next to price, Relative Strength and Momentum are the most important indicators we analyze.

Investors want to know two things; is price moving (momentum) and is it performing better than its alternatives (relative strength).

If you worked for a Mutual Fund or Hedge fund, your boss is going to ask – “are you outperforming your competitors and are you in stocks that are moving”. After all, that’s what they hire you to do and if you want to stick around, the answer better be yes!

So what’s that got to do with small-caps today? Just everything …..

The last time the Russell 2000 Small-cap Index was at these levels relative to the Large-cap Nasdaq 100 Index, Small-cap stocks went on a historic run, particularly relative to those large-caps (yellow box in chart below).

Here, we’re using IWM as a proxy for the Russell 2000 Small-cap Index and QQQ as a proxy for the Nasdaq 100 large cap Index.

So, is it just a coincidence that Small-caps find themselves back at the same levels they were 20 years ago, just before they took the bull by the horns?

It would make sense, that if Small-caps are ever going to start to outperform the big boys in the Nasdaq 100 again, this would be a perfectly logical time for that to start.

Coincidence or not, prices are down near historic support. Momentum is building with bullish momentum divergences in the RSI on both the daily and weekly timeframes.

And because shifts in momentum leads price (in both directions), if momentum is moving up, ahead of prices, price should follow.

How did Small-caps perform vs the Large-cap Nasdaq last time they were at these prices?

And so far, that’s exactly what we’ve seen throughout September.

While the mega-cap stocks of the Nasdaq 100 are down over 11% as of this writing, Small-caps are holding up pretty well —off by -2.49%.

Remember, relative strength is about being up by more or down by less than the alternatives. And that’s exactly what we’re seeing between small caps (IWM) and mega-large (QQQ).

So, if you’re going to ask me what’s next? Well, I wouldn’t be surprised if the same pundits that were complaining about big Tech being the only players leading the market higher, will be the first ones complaining that Tech’s underperformance is dragging down the indexes.

While they’re busy doing that, we’ll do what we always do, spend our energy looking for the next potential winners. And right now, it looks like small and mid cap growth stocks are making a run at yesterday’s winners.

Until next time, invest wisely…

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