December 14th, 2009

Large or Small, A Correction

Last week, in a comment about a New York Times article, I wrote:

“The S&P 500 Index, the solid blue line is hard to see when overlaid on the bar graph of the OEF, the S&P 100 Index because they’re almost identical. Granted, small-caps marginally outpaced large-caps during July-October but that advantage has eroded since.”

I find that I may not have been comparing sufficiently dissimilar indexes. Because the S&P constructs their indexes by capital weighting them, the S&P100, a subset of the 500 stock index comprised of the largest stocks looks identical. But when you compare with a true small cap index you find a more interesting divergence.

Investors use any of a multitude on indexes to monitor the market’s action. There’s the granddaddy of them all, the Dow Jones Industrial Average, an index of stock prices of the country’s 30 largest stocks. A broader gauge is the S&P 500 Index which combines the stocks of top 500 public companies. An even broader index is the Russell 3000 Index. Furthermore, the broader indexes are subdivided into subsets of like companies, like companies considered small-cap, mid-cap, growth or value.

I usually focus my market monitoring to the S&P 500 Index to the exclusion of all the others but something caught my eye this weekend and I need to correct what I wrote last week: participation in the market’s advance was actually becoming narrower over the past several months. Large-caps have continued to forge ahead while small-caps and, to a lessor extent, mid-caps have consolidated.

The “dash for trash”, when money was flowing into the stock of almost any small to mid-sized company forcing their single-digit prices to double and sometimes triple off their market crash bottoms, ended in September. If there’s going to be higher income tax rates next year as Congress moves to close the Federal budget deficit, then it makes sense to capture those small cap profits this year, at the lower rates. Here’s a chart of the S&P 600, an Index of small caps (click on images to enlarge):

Small caps broke above the neckline of the market’s inverted head and shoulders bottom in July with a two and a half month, 25% bull market spurt. Since mid-September, these 600 small cap stocks have been forming a symetrical triangle. By the way, the Russell 2000 Index, a broader index of smaller capitalization stocks looks the same.

By comparison, the Dow 30 Industrial Average hasn’t shown any indication of a consolidation:
The chart of the Russell 1000 Large Cap Index shows a similar pattern:

Interesting, but what does it mean, how do you play it? I guess the answer rests in whether you’re looking for a market correction in the new year or a resumption of the bull market. As I’ve written before, I see both happening next year …. a correction first followed by new highs later in the year. The small caps, since they’ve had the greatest gains this year may have consolidated already and will lead the market higher next year. A quick and not overly steep consolidation after New Years will be concentrated in the large caps.

That’s my guess. What’s yours?

Subscribe below or click here to learn more about help for navigating turbulent markets.
  • Anonymous

    Any good momentum material stocks you like? I know you mention AKS before??

  • Joe

    Still like AKS. I also still like CENX although it's already had a hefty breakout last week and this morning. Both could be great longer-term (6 months) momentum movers.

  • Z

    Guru, I thought you had gotten bearish on us?

    I think you play it hedged.

    For some stocks I still see more upside and see potential for the SPX to rise another 5% into the end of Dec or early Jan. (On your facebook group back in Aug – I said much higher but I see some deterioration and it seems like the big boys are selling into rallies).

    On the downside I see up to a 30% retrace of the rally after this exhausts… I see this sometime between now and Jan 15th.

    So short term (1mth) more upside possible, longer term bearish. Hedge long/short seems like the best option now..

  • Joe

    Z, I'm not sure we're that far apart. I stick with my target of 1125-1150 (your 5% more) and a correction of 15% through March (less severe than your 30% by Jan. 15) and then an upturn through remainder of the year.

    And I still have the call/SDS hedges I described several weeks ago even if it's hurting right now.

    So you and I are still in sync perhaps off by degrees.

  • turtle

    Thank you for a great website.
    Any thoughts on gold longer term?

  • Joe

    Turtle, I'm not the only one who's seen or commented about this but GLD has had three legs up (including the current one) since it started trading at the end of 2004, all following fairly similar patterns. If the current leg isn't at the top then it's fairly close to it.

    Many also say that gold has a seasonal run from through the winter, from Oct to March-April. So we may see one more run up but I'll take that opportunity to sell.

  • Anonymous

    Seasonally,gold peaks in mid January-

  • Anonymous

    Guru,,looks like the banks are repaying TARP money back just in time to issue end of yr bonuses in stock.Combine that with a correction expected soon.Anyway the average Joe can go along for that nice ride too?? Thanks for any info.

  • Pingback: Large Cap or Small, the Argument Continues | Stock Chartist()