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Small Caps Hold the Key to the Summer Rally


Schaeffer's Senior Technical Strategist sees small-caps leadership as a catalyst for a broad-market bounce.

I've long said I want to see small-cap leadership for a broad-based buying spree. This is exactly what we saw from October through March, in the midst of a huge rally and the best first quarter for the S&P 500 Index (SPX) since 1998.

One of the big concerns noted by the bears recently has been some weakening internals. More specifically, the advance/decline data has been weakening, suggesting that while the overall market might be going higher, fewer stocks are moving higher with it.

This is a concern, as you need broad-market participation for the rally to last. In fact, I talked some about this with the Wall Street Journal yesterday. You can read the article here, but be aware that you need to have a subscription to view the entire piece.

I agree some of the internals are weakening and this is clearly a concern; yet, one potential big positive is the action in small caps since August hit. It's almost like they were waiting for the month to start before taking off.

Now, I'll admit small caps have drastically underperformed, and this could just be a short-term blip. But as you can see in the chart below, over the past year, the last time the relative strength of the iShares Russell 2000 Index ETF (IWM) versus the SPX was as low as it's been recently was last October. (See chart below, courtesy of

Click to enlarge

I'm bullish and I've been bullish on the overall market since mid-June. Sentiment is still too low for a major top to be forming anytime soon, in my opinion. With that said, watch small caps, as they very well could be the key to a continuation of the surprise summer rally.

This article by Ryan Detrick was originally published on Schaeffer's Investment Research.

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