As the Dow continues to defy gravity by making progressively higher all-time highs, market watchers have pointed out with some alarm that small-cap stocks have not recently been a part of the record high club. In fact, as the large-cap Dow climbed sharply for much of September and then started October with a bang, making new all-time highs, the small-cap Russell 2000 index spent September mostly in a free fall from its August highs. The beginning of October thus far has been even less impressive for smaller companies, as the Russell 2000 has continued to lag way behind its big brothers – the Dow and S&P 500.
Market Divergence
Typically referred to as a ‘divergence,’ the opposing trajectories of large- and small-cap stocks are seen by some as a screaming red flag indicating that a major market move may be imminent, as divergences must ultimately be resolved one way or the other. So which one will it be – will the Russell 2000 play catch-up with its large-cap counterparts, or will the Dow and S&P 500 come tumbling down to follow small-cap weakness?
What’s Next?
Unfortunately, popular sentiment would more likely lean towards the latter scenario, as small-cap stocks have traditionally been seen as a leading indicator for both the economy and the markets. We believe, though, that this type of thinking may be somewhat outdated, and that recent economic growth and strength could be a catalyst for an impending small-cap rebound. Wednesday’s price action for the Russell 2000 showed a solid rally that could signal the beginnings of such a rebound.
The Chart
Below is a chart showing the relative price moves of the Dow Jones Industrial Average and the Russell 2000 for the past few months, with a clear divergence beginning in September:
Source: TradingView
{loadposition user99}