Small Caps Are Lagging. Investors Should Be More Concerned When They Lead

Summary: SPX made a new all-time high (ATH) last week. DJIA and NDX were not far behind. And the broadest measure of the US stock market comprising 98% of stocks came just 0.1% shy of a new ATH.

By contrast, small caps are lagging. They have retained none of their gains made over the past 1-1/2 years and haven't been close to a new ATH in 10 months. Should investors be worried?

By most measures, the answer is probably not. Small cap underperformance has more often marked a low in SPX, not a high. Investors should be more worried when small caps - which are highly speculative and high beta - lead, as this has most often been a feature of major bull market tops, the reverse of the situation we have now.

Last week, SPX made a new all-time high (ATH). The DJIA equaled its ATH from October 2018 and NDX came within 1% of its ATH from just last month. The broadest measure of the US stock market, the Russell 3000, which comprises 98% of stocks, exceeded its May high and came within 0.1% of its October 2018 ATH. By most measures, US stock prices are doing well. Enlarge any chart by clicking on it.



So naturally some investors are highlighting the relative weakness of the small cap index, the Russell 2000, which is lagging every other index. It's currently 12% below its ATH from August 2018, under both its 50-d and 200-d and has retained none of the gains made since November 2017, 1-1/2 years ago.



There's no doubt that RUT is weak and that investors in small caps should take note. But should investors in the broader market care more about the weakness in RUT or the strength of the other indices?

Fund managers interviewed by Bloomberg believe they should care more about RUT, calling small caps a good barometer on the economy and a leading indicator for the broader indices (that article is here).


In particular, the relative weakness in RUT versus the broader market is highlighted as being prescient of domestic economic weakness that usually presages a fall in the large cap indices.