While the S&P 500 and Dow Jones Industrial Average have continued to power to new highs seemingly everyday this summer, the small-cap Russell 2000 Index has been OK with sitting the dance out completely.
After peaking in March, strategists at Renaissance Macro Research note the Russell 2000 Index is now at new year-to-date relative lows versus the S&P 500. Over the last six months, the Russell 2000 Index — which houses smaller U.S. focused companies — is up a mere 1.9%. The S&P 500 and Dow have rallied to the tune of 15% and 10%, respectively.
"The divergence is notable, and we are starting to see bearish interval signals develop," says RenMac strategist Jeff deGraaf.
Underneath the hood of the Russell 2000, the trends are perhaps even more alarming.
Only 62% of Russell 2000 issues are trading above their 200-day moving average, RenMac notes. Roughly 27% of small-cap pharma and biotech stocks — which tend to dominate the Russell 2000 — are above their 200-day moving averages.
The relative underperformance of the Russell 2000 Index could be viewed as a red flag for market bulls.
In effect, the message from the small-caps may be that U.S. economic growth is poised to slow into the end of the year amid the spreading COVID-19 Delta variant and elevated inflation. Whereas these macro effects would initially harm profits at smaller companies the most, bottom lines at bigger companies that comprise the S&P 500 would hardly be immune (and by extension, neither would-be investors).
For now, RenMac's deGraaf believes it's safe to long the Russell's underwhelming posture. But the index warrants greater attention among investors moving forward.
"We’ll need to see further internal deterioration and a break below absolute support before turning outright bearish on the index. Until then, the way we would be playing this neutral outlook in small-caps is by focusing on owning relative breakouts and leadership while cutting loose relative breakdowns. We also see opportunity for pair trading large-cap longs vs small-cap shorts," deGraaf says.
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