Mid and Small Caps Require Patience

01/07/2014 10:30 am EST


Thomas Aspray

, Professional Trader & Analyst

MoneyShow’s Tom Aspray takes a technical look at the mid- and small-cap sectors in search of potential buy candidates in the event of a sharp correction.

The week started off on a choppy note as the major averages swung in and out of positive territory with all, except the utilities and financials, closing lower. Market internals were slightly negative, which has kept the McClellan oscillator in its short-term downtrend. It has dropped to +60 from a high of +170 on December 24.

The PowerShares QQQ Trust (QQQ) continues to act the strongest technically as the daily technical studies are still in clear up trends. The Spyder Trust (SPY) is looking considerably weaker as the daily studies are closer to giving short-term sell signals.

The press has been noting that investors have been favoring the small caps as stocks such as Zale Corp. (ZLC) was up 280% in 2013. The technical evidence suggests that investors should be patient about making new investments in the mid- and small-cap area.

On Monday, both the mid-cap S&P 400 and small-cap S&P 600 rallied above the highs of the prior three days before closing lower. The analysis of the number of stocks above their 50-day MAs (from Index Indicators) does suggest that their rallies are weakening, which allows one to target new buy levels for the two ETFs that track these two indices.

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Chart Analysis: The daily chart of the S&P 400 (MID) shows the new closing high of 1342.53 at the end of 2013, up 31.5% for the year. It closed 2012 at 1020.43.

  • There is trend line support, line a, in the 1300 area along with the quarterly pivot.

  • There is further support in the 1255-1270 area with the quarterly projected pivot support at 1258.

  • In May, the five-day moving average of the number of stocks above their 50-day MAs hit a high of well over 80% (point 1).

  • In June, a lower high (point 2) was formed, and in both instances, the peaks were followed by market corrections.

  • The MA of the % had a slightly lower high in October, point 3, but the S&P 400 did manage to gain approximately 3.2% after the percentage had turned lower.

  • These gains were less dramatic than when the moving average of the % had just turned up from oversold levels in the 33-40% area.

  • As the S&P 400 peaked at the end of 2013 (point 4), the MA percentage indicated that only 64% of the S&P 400 stocks were above their 50-day MAs.

  • The mean was just tested and the lower highs are consistent with a weakening market.

The daily chart of the S&P 600 (SP600) made its high of 668.70 on December 26 and was up 39.8% in 2013.

  • The chart shows that it closed Monday below last week’s low so it is now in a short-term downtrend.

  • The quarterly pivot is at 641.47 with the uptrend, line c, a bit lower.

  • In December, the low was 632.24 with the November low at 621.68, which is 5% below current levels.

  • The moving average (in red) of the S&P 600 stocks above their 50-day MAs shows a similar pattern as the S&P 400.

  • The peak in May (point 5) coincided with the price high while the July high (point 6) preceded the price high by about two weeks.

  • The MA peaked in October at around 69 when the S&P 600 was at 640.

  • The late 2013 high was 4.4% above the October high.

  • The MA has turned down after slightly exceeding the mean at 63.1% with the uptrend, line d, at 51%.

NEXT PAGE: 2 ETFs to Watch


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The weekly chart of the iShares Core S&P 400 (IJH) shows that a doji was formed last week. Therefore, a weekly close below $132.04 will trigger an LCD sell signal.

  • The data on the chart (from Monringstar.com) shows that IJH yields 1.29% with a low expense ratio of 0.15%.

  • There is next good support at $129.74, which is the quarterly pivot.

  • The rising 20-week EMA is at $128.35 with more important support in the $125.40-$126.26 area and the early August highs.

  • The relative performance peaked in October and dropped below its WMA in early November.

  • The RS line has good support at line b.

  • The weekly OBV staged a strong breakout last August as it moved above the resistance at line c.

  • The OBV could drop below its WMA this week.

The weekly chart of the iShares Core S&P Small-Cap (IJR) shows that it is already trading below the prior two week lows.

  • The quarterly pivot is at $105.29 with the rising 20-week EMA at $103.68.

  • There is additional support at $102.29, which is 4.75% below Monday’s close.

  • The relative performance had its initial high in October and has twice tested this high, line e.

  • The RS analysis gave a strong signal in June that it was starting to outperform the S&P 500 when it moved above resistance at line f.

  • The weekly on-balance volume (OBV) has formed a short-term negative divergence, line g.

  • The OBV is still above its WMA with long-term support at line h.

  • The daily OBV (not shown) shows a series of negative divergences as it peaked in late October.

What It Means: The technical action of both the S&P 400 and S&P 600 indicates that they are forming short-term tops. When a market corrects, the mid- and small-cap stocks are often sold first as they are considered more speculative. Therefore, they are likely to correct in a market decline than the Dow Industrials or S&P 500.

On the other hand, if the economy continues to strengthen as I expect, the mid and small caps should again start to lead the S&P 500 in 2014. I would look to buy the ETFs at stronger support.

How to Profit: For the iShares Core S&P 400 (IJH), go 50% long at $128.18 and 50% long at $127.89, with a stop at $124.58 (risk of approx. 2.6%).

For the iShares Core S&P Small-Cap (IJR), go 50% long at $104.66 and 50% long at $102.89, with a stop at $99.55 (risk of approx. 4.1%).

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