Small Caps: The Trend Remains Your Friend — Evening Brief – 10.21.24
The recent surge in the small-cap Russell 2000 Index has rekindled optimism that this segment of the equities market is poised for a further recovery following an extended period of underperformance.
The recent surge in optimism is reassuring; however, the onus remains on small cap stocks to demonstrate their relative strength versus some of the broader equity market indexes. Year-to-date comparisons indicate that small-cap stocks have significant ground to cover. The iShares Small-Cap Core ETF (IJR) continues to lag the SPDR S&P 500 ETF Trust (SPY), with IJR achieving a 10.9% increase compared to SPY’s 23.7% rise.
Nonetheless, over the past month, the IJR has significantly narrowed the disparity and is now in close competition with the SPY, both achieving almost 4% gains. It is reassuring that IJR’s technical profile appears robust recently.
In the lens of technical analysis, the two prior corrective declines of 11% and 14% in the IJR have managed to find support at the 200-day moving average on April 19 and August 5, respectively, which suggests that the major uptrend since its October 27, 2023, swing low remains intact.
In addition, the daily Relative Strength Indicator (RSI) momentum gauge has continued to print a series of higher lows since early August, which suggests the medium-term bullish momentum has resurfaced.
Although the argument for a contrarian view in small-cap stocks becomes increasingly persuasive, the prevailing trend remains your friend. Evaluating IJR against a broad array of ETFs for year-to-date performance indicates that small-cap stocks have lagged most segments of the equity market. The reversion-to-the-mean effect indicates a potential normalization favoring small companies.
“Small caps have been stuck in a consolidation range over the last few months as investors questioned the likelihood of a soft-landing scenario and the path of monetary policy,” said Adam Turnquist, chief technical strategist at LPL Financial. “Small caps tend to be more sensitive to economic conditions and interest rates versus their larger cap peers.”
The anticipation that the Federal Reserve will continue to cut interest rates at a time when the US economy appears to be expanding may trigger a prolonged small-cap rise. For portfolios that are underweight in small caps or have no allocation, one could contend that the timing is opportune for undertaking a calculated risk that the optimists may be correct this time.