One of the deepest oversold environments that we have seen over the past decade has helped to provide investors with a much-needed reprieve, but now the real work begins for small caps. Quickly approaching significant overhead supply on multiple fronts, a successful break above the 1460 level will the first step in helping to repair the severe structural damage that has been inflicted over the past few months. To put this damage in perspective, not only did the Russell take out the ascending trendline that had been in place since the ‘09 lows, but the index has not traded above its respective 50 or 200-day moving averages since early October. To put it in perspective, it would take another 12% move just to get us back to the descending 200-day. Needless to say, despite the robust move of the past couple of weeks, we’re far from out of the woods.
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With small cap equities struggling to regain their mojo, I’m always on the lookout for green shoots in an otherwise challenging tape. While there are unfortunately few to highlight while rummaging through the wreckage, I do want to draw your attention to the slight improvement being exhibited by the long-suffering financials sector. Up 3.1% over the past month, compared with 0.6% for the Russell 2000, financials have provided the 2nd best performance behind utilities (yeah, I found that odd as well since they historically do not trade in a similar fashion) since late October. Many times, relative improvement will lead the absolute turn, which is why the sector’s breakout through a two-year downtrend is noteworthy. Make no mistake, the absolute trend for the sector remains damaged, but while the sector attempts to gain its footing at significant longer-term support, the relative improvement is a welcomed development. Insurance has been a standout on the long side (favorite names included in today’s note), but I have a difficult time believing that the sector can truly differentiate itself without the all-important banks participating - something that has yet to present itself.
Well, the multiple oversold signals finally took hold, as the February lows for small and mid-caps have held…for now. A welcomed short-term sign as the calendar turns from foe to friend but make no mistake – these indices have suffered substantial technical damage, rattling the underlying foundation that has been so resilient over the past 30-months. I’ll be keeping a close eye on how the Russell handles the 1600-1620 resistance level – an important first test as the current oversold rally attempts to gain momentum. The bulls need to respond, and they need to respond in dramatic fashion over the following weeks and months. Failure to do so and the recent test of the February lows will just be a speed bump on an eventual move lower.
The much-anticipated seasonal headwinds and signs of growing risk aversion beneath the surface have had little impact on the larger cap indices, but very quietly small caps have felt the effects, modestly pulling back a touch over 2% from their recent highs. While the consolidation has been broad, growth (-2.1%) has fared better than value (-2.9%), with trends still strongly supporting the former. Relatively speaking - since peaking in July - small caps have failed to keep pace with their larger cap brethren as market leadership continues to narrow. I wouldn’t be surprised if this churning persists for another few weeks, but we’re on the cusp of an oversold signal (a message further reinforced by relative valuation) which should provide some much-needed relative momentum as seasonality abates and upward momentum develops itself into year-end.
Relentless, absolutely relentless. This market has brushed aside historical seasonality in its steady march to fresh highs. Admittedly, I believed that the signs of growing risk aversion percolating beneath the surface (cyclicals losing near-term momentum to defensives) tied in very nicely with the seasonal headwinds that tend to build towards the back half of the summer. Trends were never in question, but the seasonal oversold opportunity before the eventual 4th quarter performance chase has yet to materialize. Will it or will this “up and to the right” market persist into year-end? I still think we’ll get a better shot in the months ahead, especially with small cap on the cusp of overbought and its most challenging month from both an absolute and relative perspective (October) on the horizon, but it’s hard not to be impressed with the tape’s overall resiliency.
This long into a bull market it’s not easy to find bullish or improving longer-term trends. It’s even harder to find stocks that possess these characteristics while also being overlooked by the sell-side - what I like to call 'undiscovered gems'. Today’s note takes a look at a handful of stocks whose price charts continue to improve but do not have a single ‘buy’ rating by the analyst community. Liquidity is always a concern at the tail end of small cap, so I’ve included only those names that trade over a million shares a day. Well, except for the chart below, WD-40. That chart was just too pretty to pass up.
While I have favored small cap over large (Small Cap's Time to Shine?), I have to admit that I’ve been more than impressed with the absolute price action of the Russell 2000. Support levels have held and bad news brushed aside, as the index punched its way to a fresh all-time high today. Unfortunately, something is gnawing at me. Maybe it’s the fact that volatility (as measured by the RVX index) has cratered back below the lower deviation band as investor complacency once again sets in. Or, perhaps it’s the lack of broad-based participation and momentum (e.g. 1-month highs, % > 50-day) that typically accompany similar rallies from deeply oversold conditions. As a trend follower, I find it difficult to argue with a break above resistance and fresh highs – I’m just going to keep some powder dry in case the skeptical voice inside my head turns out to right.
Maybe it’s the contrarian in me, but I’ve always been intrigued with stocks that have strong or improving technical attributes, while at the same time facing a great deal of investor skepticism. The chart below of Tenet Healthcare is a great example of what can transpire when an improving trend collides with elevated short interest. Today’s (05/03/18) report takes a look at the twenty names (THC included) where the charts are strong or improving, while short interest as a percent of float is quite elevated.
Interesting price action yesterday (03/27/18) would be an understatement. I was working up a note on small caps when I had to leave mid afternoon to catch a flight. That’s when the bears turned what had been a quiet, if uneventful day for stocks into gut check time for the bulls or as McCroskey so eloquently put it -https://youtu.be/hd1ciPnTGKg. So my apologies for the heavy dose of Russell 2000 charts in today’s piece, but I forgot my laptop at home and it’s probably fitting given their leadership off the February lows - outperformance which I believe has some legs to it (Small Cap's Time to Shine?- 2/16/18).
Small caps have responded favorably to their recent oversold setup, rally 7% off of last Friday’s lows. With the easy money behind us, how the Russell responds to its now descending 50-day moving average will be telling. Strong tapes are able to accelerate through resistance with ease, leaving the bears to ponder what just happened. Breadth and momentum have been solid, but there have been two attributes missing during this move that need to be monitored closely. The first and admittedly more important one is credit. While credit indices have bounced off their respective lows as well, they haven’t done it with the same fervor as equities. Persistent divergences on continued equity strength in the weeks ahead would be an unsettling message. Secondly, while only by 80 bps, small caps have lagged large caps during this relief rally.
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