What About Small Caps?

There are two primary reasons to watch the performance of small cap versus their large cap brethren. First, being a generally higher risk category, small caps provide an insight into the degree of risk appetite investors have for equities. Second, because they tend to be more US centric in their businesses, the performance can provide some insight into investors' expectations on the US economy, in general, and US centric companies, specifically. So, what does the accompanying chart and related data reveal?

The underperformance since the April 23rd high is apparent, but not so dramatic as to warrant ringing the bearish bell on the sector and market overall. In fact, since the bull market got started in March 2009, the group has underperformed the broad market more dramatically last fall only to rebound quite nicely shortly thereafter. Moreover, last fall's relative performance slide was accompanied by a meaningful divergence breaking to a lower low while the S&P 500 not only held above its correction low but was actually trending upward. Contrast that with the present, where it has yet to break below its previous pullback low. And even if it does, it does not appear to divergence in the dramatic fashion serious market tops typically indicate.

When looking at the index itself, there is nothing that stands out vis a vis the action of the S&P 500. Both have deteriorating long term Mega Trends, solidly down near term trends (momentum and MACD), and are into strong short term oversold territory.

From a fundamental point of view, the higher P/E for the group and higher projected growth in earnings for the next 12 months compared to the large cap S&P 500 is something of a concern but does not fall into grossly overvalued territory.

Investment Strategy Implications

Small caps are not helpful for the bull case. Neither are they overly hurtful. At least, not yet.

The bounce is still the most likely next move for stocks. What follows will help clarify the picture and should lead to a resolution of the multi month trading range that stocks have been locked into since last fall.