Many market pundits were noting the significant underperformance of US small caps a month ago. The benchmark Russell 2000 (RUT) peaked in early 2014, even as the large cap S&P 500 (SPX) made new all-time highs in the spring and summer. Sentiment turned quite negative on small caps versus large caps as the year progressed.
What was a bit unusual was the underperformance of US small caps versus more multinational US large caps while the US Dollar was rising. Intermarket analysis tells us that large multinationals tend to underperform US domestic firms during periods of a rising dollar, all else equal. The US Dollar may be breaking out of a bull flag, on its way to further multi year highs.
US Dollar Weekly Chart – Bull Flag Pattern?
It is well-known that the November-April period is historically quite strong for US stocks. Combine a rising USD with the typically strong November-April period for stocks, as well as weak Russell 2000 sentiment since the spring, and we may be developing a perfect storm for US small caps to break this streak of poor relative performance.
Russell 2000 to S&P 500 Relative Performance Chart
The Russell 2000 broke below a defined range in October, only to recapture the key 1080-1100 level, showing relative strength in the latter half of October. While the pace of the last two weeks won’t be sustained, this false breakdown and subsequent outperformance could be just the beginning for US small caps.
Russell 2000 Daily Chart – False Breakdown?
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No position in any of the mentioned securities at the time of publication. Any opinions expressed herein are solely those of the author, and do not in any way represent the views or opinions of any other person or entity.
