First the good news. The Dow made another record last week. Now the troubling news: Russell 2000—an index of small cap stocks—is down 7 percent on the year.
You might be asking: What does the large-cap Dow have to do with the small-cap Russell 2000? Well, traders like to see rallies in all the broad market indexes to confirm bullishness because a record Dow may have more to do with only the 30 stocks in the index instead of the market in general. If smaller companies are falling, then there's the possibility that other stocks will soon follow, including the mighty Dow.
But Gina Sanchez, founder of Chantico Global, isn’t that worried. She sees the Russell's drop as a sign that investors aren't pulling money out of small caps and putting it into large caps. Instead, she worries that they are holding off on buying stocks altogether.
"What's happening in the Russell is an indicator of a rotation that's happening," said Sanchez, a CNBC contributor. "Right now, we're selling off all the highest P/E names out here. And, the Russell 2000 is rife with them. The Dow is obviously the bluest of blue chip stocks. Yet it's been hanging in there, but it hasn't exactly been knocking the lights out. My concern is this isn't necessarily just a defensive rotation. I think that money is coming onto the sidelines and is going to stay there for the summer."
Richard Ross, global technical strategist at Auerbach Grayson, says the selling in small caps is confirming another problem for the Dow: the technical setup.
"Clearly, in 2014, the Russell's pain has been the Dow's gain," said Ross. "But, this 'too-big-to-fail' investment strategy is really destined for only one thing if my chart work is correct, and that's failure."
In the near term, "Talking Numbers" contributor Ross sees the Dow continuing to struggle to break above 16,600. That may lead to a pullback toward 15,820, where the Dow's 200-day moving average is moving alongside the Dow's uptrend support line.
However, it's the long-term chart that has Ross worried. He sees the Dow as repeating the same technical moves as it did last decade. Here are the similarities he counts:
1. An initial break above the 200-week moving average (2003 and 2010)
2. After breaking above the 200-week moving average, the Dow gains somewhere between 45 and 50 percent over the course of four years.
3. When the Dow peaks after those four years, it's at a point that’s 25 percent higher than its 200-week moving average.
"It all adds up to a major decline: [a] 20 percent down move to that 200-week" moving average, said Ross. "I think we get it."
To see the full discussion on the Dow, with Sanchez on the fundamentals and Ross on the technicals, watch the above video.
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