Trading at 4-month lows, small caps continue to languish beneath resistance on multiple fronts. Their lethargic behavior of late is in line with historic market characteristics, as credit led with a similar reversal at November resistance levels. As risk aversion steadily builds globally, the lower quality nature of small caps has weighed heavily on their relative performance. Not a surprise, but a quick review of the S&P Quality Rankings for Stocks, shows a markedly different profile for large and small caps. For the S&P 500, 56% of names (equal weighted) possess a ranking of a B+ (cutoff for above/below average) or higher, while the Russell 2000 is comprised of a mere 16%. We have our concerns about markets globally, and this mounting rotation away from risk assets will only weigh on small cap indices given their higher beta and lower quality characteristics. Not yet oversold, a move back into the 1450 zone wouldn’t shock us before buy signals start flashing green.
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Maintaining the trend that has been in place for the better part of the past decade, growth has trounced value off the low, outperforming by 800 basis points (31% vs. 23%). As the chart below highlights, trying to call an end to growth’s dominance has been a treacherous one, with multiple head fakes along the way. However, there have been periods of time where this leadership style is due for a breather, and I believe that we’re quickly approaching one. Absent the ’15 blow off, a rotation has tended to take place as overbought conditions built near the top end of the trading range. Yes, we can surely see a repeat of ’15, where growth took out the top end of this range, but pressing the style here seems a bit late in my view – better opportunities are sure to arise on the horizon as gains are digested.
While the Russell 2000 remains 10+% off its high and struggles to exhibit any significant momentum over the past six weeks, I wanted to draw your attention to a handful of names that caught my eye. While I like charts that are up and to the right, I really like those that have been basing for a while, as sentiment slowly moves from bearish to bullish, and have yet to be fully embraced by the consensus. Today’s note (4/10/19) takes a look at 8 such examples - stocks that are on the cusp of significant breakouts from huge bases.
It has not been a pleasant few days for the bulls. First the rally in small caps has been aggressively sold beneath resistance, then my University at Buffalo Bulls got smoked in their 2nd round match-up against Texas Tech spoiling what had been a fantastic season. With respect to the former, the past couple of weeks are exactly what you didn’t want to see, as hopeful price action to start the year gave way to negative momentum beneath resistance. Keep an eye on the 1450 level for the Russell - failure here and the December lows won’t feel so distant.
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.
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.
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