The Stock Market’s Small Cap Problem

The extraordinary performance of U.S. stocks over the past six years has been like the 1960s Boston Celtics: Dominant and unbeatable. But is the tide changing?

From 2009 to present the SPDR S&P 500 ETF (NYSEARCA:SPY) has gained almost +135%, while the SPDR S&P MidCap 400 ETF (NYSEARCA:MDY) surged +149.72% and the iShares S&P SmallCap 600 (NYSEARCA:IJR) jumped +153%. However great that may be, the shorter-term trend for stocks has dramatically changed.

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The chart below plots the performance of SPY, MDY, and IJR since the June 23rd peak. As you can see, the short-term trend in U.S. stock prices is down. But did you notice how small and mid cap stocks are now leading on the way down? The fact that smaller and riskier stocks are falling faster compared to larger stocks is indicative of a significant sentiment change by investors. Simply put, the appetite for higher risk securities has quickly evaporated.

MDY, SPY, IJR August 2015 Chart

The equal-weight version of S&P 500 (NYSEARCA:RSP) offers a more balanced view of the U.S. stock market and shows the average stock within the S&P (SNP:^GSPC) is currently in corrective mode. RSP just breached its 200-day moving average in the Aug. 7th trading session and RSP has registered lower lows and lower highs since May.

Ahead of the latest mini-correction, we warned readers in the August 2015 issue of ETF Profit Strategies (issued on 7/24/15):

“Although the year-to-date (YTD) performance for large, mid, and small cap U.S. stocks is still marginally up, performance over the past three-months is deteriorating and negative for all three groups. The fact that mid and small caps are now laggards, is a signal that appetite for smaller and riskier companies has waned. Via our Weekly Picks, we added the Direxion Small Cap Bear -3x ETF (NYSEARCA:TZA) at $9.95 on July 9. This is a short-term trade that should benefit from any further decline in small caps.”

Since our July 9 entry, TZA has jumped +9.01% while small caps have sunk. TZA offers 300% daily inverse exposure and is built to increase in value when U.S. small caps (NYSEARCA:IWM) stocks fall.

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