Small Cap Value Outperform-ance Might Have Legs
Many readers here are likely very aware of the style shock across most asset classes that developed in mid September as bond yields bounced higher, triggering a teeth rattling reversion between growth and value stocks and between low volatility versus high beta themes. A majority of investors and strategists see this as temporary, while the minority, including myself, view the reversion as potentially the first shot across the bow of reversal that could extend into and through Q4.
For now the majority apparently are correct given that the trend of value vs growth remains down. However, as I’ve discussed here repeatedly, I encourage investors to add more cyclicality to portfolios given the top down cycle work I’ve published along with the bottom up improvement evident in semis, industrials and truckers to name just a few examples.
This week’s charts begins with Russell small-cap value index (RUJ) in the top panel. Consider that the Dec. 2018 lows retraced exactly 62% of the prior cycle’s rally from 2016-2018, temporarily below its rising 200-week moving average secular uptrend. That defines the lows for a new cycle. After the initial rebound, the RUJ has effectively traded sideways in a broad band above the 200-week MA. Not great but also not bad and certainly not as bad as the bears have declared. It’s simply a consolidation and if resolved to the upside, above the highs at 126, this would signal the second major bullish leg within a new market cycle.
Now look at the RUJ’s relative performance to large-cap growth (RLG), the market’s dominant leadership since 2017, in the second panel. While it’s premature to state an upside trend reversal has convincingly developed, it is right on the cusp of doing so. Put differently, if you are overly exposed to large-cap growth through technology stocks or simply through S&P index products, this chart suggests you should be prepared to increase exposure to small-cap value or similar products.
The bottom panel illustrates the Regional Bank ETF (KRE) which is another way to build exposure to smid-cap value. Not surprisingly, the price pattern is very similar to the small-cap value (RUJ), that is, trading sideways for much of the past two quarters. A move above the resistance band between 55.74-57.52 would be needed to confirm a new upside move. I’m illustrating this chart now given that the very short-term pullback developing over the past two weeks is now testing an important support level at the 200-week MA near 52.
Bottom Line: The technical backdrop is set up to support a rebound in small-cap value driven by cyclicals, including banks, in the coming weeks. For those unconvinced, wait for the breakouts above the summer highs, but for those who agree with this view I recommend adding exposure at current levels.
