Small Caps and Cyclicals Showing Signs of Improving
After a wobbly couple of weeks, Technology stocks rebounded with a vengeance over the past week raising questions from readers whether Technology’s leadership will continue unchallenged. To be clear, I continue view technology as a core long-term overweight in a portfolio but there are divergences developing that continue to suggest Technology’s leadership may be in the very early stages of taking a well-deserved pause.
There are two related divergences I recommend investors and traders pay very close attention to in the coming weeks and months. The first is that while the Nasdaq and S&P Technology indices made new absolute price highs last week, their relative performance versus the S&P 500 did not. At this point they are only short-term divergence so it’s important not to overreact, but changing trends all begin in the short-term so I’ll be writing about this more in the coming weeks
Secondly, Software, as represented by the IGV Software ETF, made marginal price highs this week but its relative performance versus the S&P 500 did not and is breaking to new multi-week lows (top panel). I view relative performance, the ratio of one security versus the market, as arguably the single most important technical tool I use and encourage readers to pay close attention when price and relative performance diverge. In my opinion, it’s often an indication capital is beginning to shift from one leadership area in the market to another.
In contrast to technology and growth stocks, small-caps and cyclicals in general, have lagged the market but are now showing evidence of improving after trading sideways in broad ranges for the past two months. The IWM small-cap ETF is noteworthy this week as it begins to resolve a two-month trading range to the upside (center panel). More importantly, the IWM’s relative performance is beginning to reverse a multi-month downtrend which is exactly the type of upside hook I like to see to signal an emerging trend.
What to do? I continue to recommend maintaining a barbell exposure within equity portfolios. Growth and technology stocks have provided excellent returns through 2020 and are not showing any long-term signs yet of peaking but are showing signs of a tactical or medium-term pause developing. Weekly momentum indicators are overbought and relative performance is showing early signs of fraying while more cyclical indices and stocks are showing signs of emerging.
Bottom line: Trim some technology and growth and add some exposure to more cyclical stocks such as small-caps (IWM).
Figure: Weekly Sector Review
Source: FSInsight, FactSet
Figure: Best and worst performance sectors over past 3 months
