When Small Cap Stocks Underperform

For the first time since early February, smaller cap Russell 2000 stocks (IWM) have underperformed larger cap S&P 500 stocks (SPY) by a full percentage point or more over 5, 10, 20, and 50 day periods.  That's pretty unusual in bull markets.  Indeed, if we look at those occasions when VIX has also been below 20 (a nice bull market filter), we only find 14 non-overlapping instances since 2006.  Over those 14 instances, SPY has been up 20 days later twelve times and only down twice, for an average 20-day gain of 2.23%.  All other instances have averaged a 20-day gain of .50%.  

(Story for another day:  When IWM has outperformed SPY by over 1% over 5-50 day periods, the average next 20-day change in SPY has been a loss:  -.31%.)

All this tells us is how stocks have behaved in the past.  Our job is to read how the market is behaving now and continually update our estimates of past patterns playing out in the present.  Could we be entering a whole new regime of small cap underperforance?  It's possible, especially given the higher valuation of small caps and concerns over the potential end of QE.

Should we show signs of basing, however, with further selling unable to push the broad list of shares lower, we could have a nice setup for bargain hunters.

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