The Small-Cap Conundrum

09/26/2014 11:00 am EST


Thomas Aspray

, Professional Trader & Analyst

Small-caps should be doing better (not worse) than large-caps if the economy is growing and the oft-overlooked mid-caps should also benefit, so MoneyShow’s Tom Aspray examines the weekly charts of the ETFs that track them to determine key levels to watch in the weeks ahead.

The relatively weak market internals on Wednesday’s rally suggested that it might not be sustainable and the weak action in the euro markets sealed the deal by Thursday’s New York opening. Nevertheless, the selling was much heavier than most expected.

It should be no surprise that the market is getting oversold with the Nasdaq 100 down almost 2% along with the Biotech sector.  Asian stocks were mostly lower as well but in early trading the EuroZone markets and S&P futures are trying to stabilize.

The McClellan oscillator has dropped to -310, which is below the early August low of -278. The Osc shows a pattern of lower lows and it would likely take a week or more before any bullish divergences could be formed. The sharp rise in the VIX is also a negative and it will take a powerful rally to reverse it back to the downside.

One difficult question—or conundrum—for many analysts is the much weaker action of the small-cap stocks. Their view is that the economy is continuing to strengthen and, if so, the small-caps stocks should be doing better not worse than the large-cap stocks.

Though the Russell 2000 is the most widely followed small-cap index, an interesting research report from reveals that, up through the end of 2013, the small-cap S&P 600 has had an annualized return of 11.05%. During the same time period, the Russell 2000 is up just 9.27%.

This is attributed to the fact that the Russell 2000 contains many more illiquid stocks and its components are adjusted in the middle of each year. In contrast, the S&P 600 components are changed by the decision of a committee.

Not much attention has been paid to the mid-cap stocks that should also benefit from a stronger economy. A look at the weekly charts of the ETFs that track both the S&P 400 and S&P 600 reveals the key levels that should be monitored in the weeks ahead.

Click to Enlarge

Chart Analysis: The NYSE Composite rallied back to near term resistance, line b, on Wednesday before reversing back to the downside. 

  • Thursday’s close was just above the monthly projected pivot support at 10,717.
  • The weekly uptrend is now at around 10,680 with the August low at 10,557.
  • The quarterly projected pivot support for the 4th quarter is calculated now at 10,483.
  • The ARMS Index, or TRIN, closed Thursday at 2.16.
  • It is more oversold now than it was at the August low when it reached 2.01.
  • It reached 2.18 in June and then 2.37 at the April lows.
  • On February 3, it closed at 3.42, which was an extreme oversold reading.
  • The NYSE needs a strong close back above 10,900 to stabilize the daily chart.

The SPDR S&P 400 MidCap (MDY) has dropped just over 3% in the past three months but is still up 3.26% YTD. 

  • The chart shows that a weekly low close doji sell signal was triggered three weeks ago (see arrow).
  • The weekly trendline support, line f, is now being tested.
  • The weekly starc- band is now at $247.34 and the August low was $246.06.
  • For October, the quarterly projected pivot support is at $243.03.
  • For October, the monthly pivot is projected to be at $253.23.
  • The weekly OBV (not shown) did confirm the early September highs but will close below its WMA this week.
  • There is strong weekly resistance at $263.39 with the weekly starc+ band at $268.87.

The SPDR S&P 600 Small Cap (SLY) is down 5.38% in the past three months and is down 3.05% YTD. So far in 2014, the results are comparable with the iShares Russell 2000 (IWM). 

  • The weekly chart shows that SLY could close below the weekly support, line h, this week.
  • SLY has dropped below the August low at $98.35 this week.
  • This makes the May low at $96.23 even a more important level of support.
  • The weekly starc- band is at $97.03 with October’s projected pivot support at $94.14.
  • The monthly pivot for October is at $100.35 and a daily close back above this level would be a plus.
  • The major resistance, line g, and the starc+ band are now at $107.11.

What it Means: If the current decline drops both the SPDR S&P 400 MidCap (MDY) and SPDR S&P 600 Small Cap (SLY) decisively below the May lows it would be a concern for the overall market.

It is important to remember that the recent highs in the S&P1500 and NYSE Composite were confirmed by their A/D lines. Therefore, the current decline needs to be viewed as a correction in the major uptrend.

How to Profit: No new recommendation.

For more on the markets, you might enjoy some of Tom’s recent articles:

Monthly OBV Analysis of Four Key Markets

The S&P 100's Ten Most Oversold

Finding the Sweet Spot in the Financial Sector

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