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Small-Cap Performance Could be a Warning Sign

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IWM has lagged SPY during the recent rally in equities.

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Obviously, all the talk on the floor today is about the Federal Reserve policy announcement at approximately 2:15 p.m. EDT this afternoon. We have seen a pretty nice run up in US equities throughout the past six trading days, with the S&P 500 Index (SPX) taking out a previous resistance area near the 1,380 area. Many people have tied this short-term rally above this level to hopes from investors for further stimulus from not only the Federal Reserve, but the European Central Bank (ECB) as well. I'm hearing more and more talk about expectations for stimulus to come from the Fed in September rather than today's meeting, though.

Taking a closer look at the recent run-up in equities, one thing stuck out to me. Since just after the July 4th holiday, small-cap stocks have underperformed large-cap stocks. Traditionally, it is always a healthy long-term sign when small caps lead large caps during a rally. As you can see from the short-term relative strength chart below, the iShares Russell 2000 Index ETF (IWM) has greatly lagged the SPDR S&P 500 ETF Trust (SPY) recently.


Click to enlarge

Looking at the IWM chart below, you can clearly see a much more troublesome chart than that of the SPX. During the recent upswing in equities, small caps failed to take out their July 19 high and actually made their third consecutive lower high in the month of July. In addition, the MACD histogram turned negative on July 12 and has yet to regain its footing in positive territory.


Click to enlarge

Going forward, I would like to see the IWM break above its descending trendline, which has connected its lower highs since its underperformance began on July 5. Until this happens, I have a hard time buying a lot of small cap stocks. Much of this technical picture could also get trumped by headline news from the Federal Reserve and/or ECB; however, this short-term technical hurdle is definitely something to keep an eye on.

This article by Joe Bell was originally published on Schaeffer's Investment Research.

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Twitter: @schaeffers
No positions in stocks mentioned.
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