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Is The Small-Cap Under-Performance A Big Deal?
After the initial pop off the September low, small-cap stocks have significantly under-performed their larger peers – is that trend as troublesome as some are claiming?
If you are closely involved with markets, you know that there are always items of concern among participants. One such concern presently is the recent under-performance on the part of small-cap stocks. In the initial ramp off of the late-September lows, small-caps performed in line or better than larger cap stocks. However, since that first week or so of the surge, smaller stocks have lagged, even as large-caps have continued to score higher highs. This has some observers worried about the “quality” of the current rally. Are those concerns warranted? We took a closer look at the situation to see if we couldn’t find a few clues.
First off, what sort of under-performance are we talking about on the part of small-caps? Well, the first pop off of the September “re-test” lows lasted about 7 days, rallying all of the indices by about 6-8%. In the roughly 2 weeks since, however, there has been quite a bifurcation in the performance of the various indices. The S&P 500 large-cap index, for example, has continued to advance, rallying nearly 3% over that time. Meanwhile, the Russell 2000 small-cap index is essentially unchanged. That dynamic has some folks worried that the rally may have run its course. Let’s check it out.
Since 1991, we have found 75 previous days in which the S&P 500 showed a 2-week gain of at least 2% while the Russell 2000 gained no better than 0.5%. We took those results and drilled down further, looking for instances that in some way matched our present circumstances. We zeroed in on 2 sets of circumstances to see if there was anything consistent in the market performance following such events.

As the chart shows, one of the factors we looked for were times, like now, when stocks were coming off of a 6-month low some time over the past month, at least in the Russell 2000. We found 20 such prior events (shown as blue dots on the chart). So did the Russell 2000 put a halt to the bounce? Not in the slightest.

Both the S&P 500 and the Russell 2000 consistently rallied in the subsequent week to 6 months. The 1-week marker was especially consistent as 18 of the 20 events showed a positive return in the of the indices. In terms of return, both indices showed stellar figures, peaking at the 3-month mark at a median +6.7% and +13.7% for the S&P 500 and Russell 2000, respectively. Needless to say, the small-cap under-performance did nothing to thwart the budding intermediate-term rallies.
It is worth noting one thing, however. Several of these occurrences were inclusive of the 6-month low within the measuring period. That is, the 6-month low took place during the S&P 500′s 2-week rally and the Russell 2000′s under-performance. That is a bit different than our present situation. The 6-month market bottom took place several weeks ago and, subsequently, both indices enjoyed a nice bounce. Thus, the 2-week measuring period has taken place after that initial bounce.
Looking at the data, those examples in which the 6-month low occurred prior to the past 2 weeks did not fare as well as the larger sample. In fact, 5 of the 6 2-month losses in both the S&P 500 and the Russell 2000 were accounted for by those occurrences when the market had bottomed prior to the past 2 weeks. Long story short – the current set-up has not been quite as bullish as those instances that included the 6-month low day in the 2-week measuring period.
Also along those “not so fast” lines comes our other study factor. We looked at those times in which the S&P 500 sat at a 2-month high following its 2-week rally (as was the case on Friday). The returns were not quite as promising. In fact, they were downright lousy.

The median return was negative from 2 weeks out to 2 months for the S&P 500, and from 1 week to 3 months for the Russell 2000. And while the Russell 2000 led way higher in the previous table, it led the way lower here, bottoming out at a median loss of -6.7% 2 months out.
So which of these studies will set the precedent for our present case? Unfortunately, the present case is the only occurrence meeting the criteria for inclusion in both categories. Therefore, in a way, it has no precedent. If we had to pick one period that showed perhaps the most similarities, it may be late November 1998. The indices had bounced strongly off of a re-test low before the under-performance of the small-caps began. While the S&P 500 was at a 2-month high, it had narrowly missed forming a 6-month low the month before. For what it’s worth, both indices were lower 3 weeks later before rebounding over the longer-term.
So is the hand-wringing over the laggard small-cap space justified? We frankly did not know so we examined the issue. Upon further inspection…we are still not sure as the results were quite conflicting. Like we have said before, however, at least now we know what we don’t know – and even have a reason for why we don’t know. That’s always better than assuming you do know.
You know?
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More from Dana Lyons, JLFMI and My401kPro.
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that's two minutes of my life i'll never get back
In otherwords, the author of this article has absolutely no idea what the small cap underpermance means. I agree with your two minutes statement.
As someone who trades the Russell daily, I'd agree that any such "this has happened before" studies are likely to lead to mixed results, RUT seems to march to it's own drummer. One aspect I've noted in it's few periods of outperformance this year is that is was dollar-related, rate hike fears possibly impacting larger firms led pension committees to move dollars to IWM from SPY & DIA. With most thinking rates hikes are a mid-2016 event, we could be seeing the same fund managers reversing this trade back to the QQQs as month-end approaches, keeping some pop but de-risking a bit.
With respect to today's action, we had a beautiful early Russell short avaialble to traders (FINALLY, goddammit) down to 50 DMA, which matched the S3 pivot, and 2m volume spikes and overall low volume suggests a reversal, perhaps back to flat to match the QQQs pre-APPL managed horizontality. It's still early, so you never know, but I elected to cover, never seen a huge down move on this pathetic volume. Another clue is when we plunge to a key DMA early, pre-11, often it's from a "buying vacuum" as those who've been goosing it for weeks wait to re-enter, and we see a V-bottom spike. Still, with 5+ hours remaining, Russell ninjas could do just about anything ...
Amazing, in less than an hour it both spiked back through opening levels to the 20MA AND returned for a 2nd touch of the 50MA (Usually such 'double touches' are more shallow in amplitude.) While noon bar's technicals suggest more carnage is possible, my spidey sense thinks a bit of a rebound is likely w/o QQQs & DIA moving in sympathy, and the 1:00 bar will signal this turnabout, but by-the-book would say stay short ...
On the first plunge around 10:15 Sold the 67 TNA puts against the long 66 puts from yesterday...also picked up 1/2 position of 73 calls on the cheap 3 weeks out (which have now as of the 12:50 plunge gotten cheaper so may add). Rolled 1/2 the long calls expiring this week to next before they lose too much value and one point up the chain...sitting tight for the moment...any big spikes and I've got a pile of 72 calls to unload...may hold them into FED announcment...not worth much/anything at the moment, might as well hold. My bet is we go lower so I'm keeping the 66 and 64 calls short. The put spread is on the house if we go lower as it was a net credit of over a $1 between the strikes when all was said and done. Think they may just try to shake out the shorts one more time before pulling the rug out. Really was fortunate to finally get a decent move lower here...was getting really f'ing tired of out rolling this nonsense the last few weeks. As I'm writing this seeing the continued slide, looks like I was a bit premature...as always...but still making great money here...no complaints... I need to add about a 2 hr offset to my trading strategy LOL...
Hope this bitch dies already.
No, you're doin' better than most, believe me, and know exactly where your risk lies, which is half the battle. Not sure if you saw that HUGE 12:54 volume burst in tNA/TZA, but wonder if it was a ninja ambush before a turnabout, the sign of a watershed event in the making, or simply a big program designed to end at 1:00.
I've got to learn to trust my method more, even when it doesn't make sense, I couldn't believe on 50% avg already low volume we'd see a major RUT dump against modest DOW losses, first time in 4 years I've seen it, not sure if you've ever seen it yourself. Perhaps my theory above about a large public fund rebalance program from IWM to QQQs (plus an AAPL earnings leak) is the culprit (?)
Anyway, I'm happy to get 1.5% for 30 mins of work after what we've seen intraday, should've gotten in again at noon, but the good news is my recent methodology tweaks appear to give me the best framework ever ... now if I can just get myself to follow 'em ALL the time :)
Your option open interest analysis was spot on, as always. Given 'em hell, JMF !
KCS,
RLTA (Russell Leveraged Traders Association, JMF & KCS pres & vice-pres)
Now that we have blown through all the normal points and nothing but thin air below...I'm watching the 4hr RSI...likely bounce point...we are getting close, but may have a little more to drop. JMHO
Haven't seen much of a turn up in OBV yet either
Call me paranoid ("OK, KCS, you're paranoid, and talking to yourself isn't a good sign either"), but is the following possible: Goldman gets a BIG RUT to COMP rebalance program from a client w/ orders to finish before 1:00, likely from inside AAPL info, so they manage the dump, pinging like a dragonfly between 20 & 50 DMAs then, just before 1:00, they dump half of their remaining allotment, to make the 1:00 bar stochastic so low that even Pisani gets in short then, at the magic 1:30 bounce time, BOOM, they bring the hammer down and head back to the 50. Or, perhaps they want me to think that, get long, then dump to mid-Oct lows. (This is why I use only technicals, so as not to think, it's overrated :) )
I've only seen this RUT action at the turns into bear markets...the ninjas never tell you when they start trapping bulls instead of bears ;)
Only when you look back over the charts a year or so later and get that "Oh there it was" epiphany
You'd think that, will all our promotional work gettin' folks excited (and likely, to lose money) trading TNA, they'd want to tell the two of us (plus that fine gentleman posting below).
Attention, Russell Ninjas: click the link to my parody blog in my ZH profile (or google my ZH handle to find it), and use the "Contact Form" at the bottom right to email me and let me know what you're gonna do. Letting two or three people make money will make it seem trading RUT is actually possible (of course, neither JMF or I believe this farce.) I'll be awaiting your note ...
Don't think those ninjas are all that into sharing the wealth...in fact those little bastards that pin a TNA strike 3$ away from VWAP on Friday close just to fuck over some guy who's counting his chickens 10 minutes too early...well they should be hanging from lamposts too come the reaping.
Still a large gap there on IWM 10/05/15 to fill as well
I still can't believe a 1.50% perf gap between IWM & QQQs, unless the '100% AAPL' strategy of hedgies 3 yrs ago is back. I still think the 50MA, which is also VWAP, is where we're heading, but today is so bizarre I'm goin' for another walk in the lovely 50 degree OH weather, leaves fully turned, to avoid doing something stupid. Signing out for now ...
Not a bad idea...idle hands are the devils tool. Enjoy your walk...I'm thinking about going out and getting in a deer stand early myself...if this drizzle subsides. Think things are covered for the rest of the week at this point. May get into a little covered call action on oil at some point but other than that, just going to let extrinsic cook off for a few days.
Must be nice to enjoy past actions as the day unfolds, instead of fretting about entry/exits like me (though I did predict a near VWAP/50DMA ending, is it possible I'm getting the hang of this? Good luck on FOMC Day).
Good call on staying short...hope you time the bounce right too and make a bundle
Yeah, I'm a Russell guy also. There have been two really big (160K plus) volume spikes on TZA today, and the rut is down (I'm long TZA at the moment, so I'm cool). Yesterday's very low volume on TZA was kinda a clue, but the RUT does march to it's own drummer. By 1300 New Yawk time, Risk looks really off, and I'm getting ready to partah...
And I'm staying short. Maybe because I was and am a fundamentals guy for a long time (bot my first stocks in 1963 after following since high school in 1955), and got reasonably well to do in my retirement. The fed and HFTs can do a lot for a long time, but sooner or later, gravity wins. (I'm also a dual pilot - aircraft and paraglider, and a skydiver, even if I am an old guy.) Gravity sucks, but it's the law.
5 for 5 regionals are in contraction, sales and profits are sliding, and inventories are building. Santa Claus may not rally this year...I ltruly belive the FED is out of gas, and NIRP ain't gonna solve the little problem with the market.
But I've been wrong before, and it has cost me. Stops are in...
Good luck...used to trade TZA many moons ago before loosing my shorts in it enough times to finally admit defeat.
Think you are right...the herd is already spending their priced in Santaclause Rally like they have done every year...think that Pavlovian response might be a heartbreaker this year.
Excellent, I foolishly had a 100% account posn but got out at the first 50 DMA touch. Nice to hear from a fundamental guy, as I'm all technical. Of course the fact that you're a Russell trader means that you're equally intelligent as you are insane, so JMF and I welcome you to the crazy club. Godspeed today.
Small Caps underperform for two STRUCTURAL reasons:
1. Further from the "free money" spigot than larger firms.
2. Not nearly as much money to buy influence in DC to feather their own nests as large companies.
Questions?
Enjoyed the comments but barely glanced at the article as I've had few positive experiences with articles that have headlines phrased as a question. I stopped trading the small cap because of the volatility, not to mention the volatility of the volatility index.