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This bullish indicator has investors feeling bearish
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Loading...Might recent small-cap weakness actually be a good thing? Not that any of the dozens of advisers I monitor think it is. On the contrary, a number of them are worried by the sector’s marked weakness.
Over the past three months, they pointed out, the large-cap dominated S&P 500 has done more than five percentage points better — 6.4% versus 1.3% — than the Russell 2000, perhaps the most widely-followed small-cap benchmark. Earlier this week, in fact, the Russell 2000 briefly dipped into negative territory for year-to-date performance.
Why is this worrisome? When trying to answer this crucial question, advisers provide lots of anecdotal evidence and repeat vacuous sayings. One popular aphorism is that “when the troops lead the generals will follow” — the idea being that it’s positive when secondary stocks (the “troops”) are outperforming the large caps (the “generals” such as General Electric and General Motors), on the theory that those large caps will have to perform particularly well just to catch up.
But I’ve seen precious little statistical support for the conventional wisdom, and I think I’ve figured out why: It doesn’t exist.
Take what I found upon entering into my PC’s statistical package 20 years of data for both the S&P 500 and the Russell 2000. I focused on how the former index performed relative to the latter, over periods as short as the trailing month to as long as the trailing 12 months. I then correlated these relative strength measures to how the S&P 500 performed subsequently over periods ranging from one month to a year.
In all cases, S&P 500 relative strength was a bullish omen. While not all of the correlations were significant at the 95% confidence level that statisticians use to determine that a pattern is genuine, many of them were. None of the correlations provided support for what conventional wisdom would have you believe.
Some of the most significant correlations existed at the three-month horizon, and they’re summarized in the table above. Notice that the S&P 500 on average gained more than 5% over the subsequent three months whenever, over the prior three months, it beat the Russell 2000 by more than 5% — as is the case since early December.
In contrast, the S&P 500’s average three-month return was a loss of more than 2% following periods in which it previously lagged the Russell 2000 by more than 5%.
Needless to say, these results don’t guarantee that the market will rise over the next three months. Large-cap relative strength is just one of many indicators that claim statistical significance, and not all of them are bullish right now.
But if you’re worried about the market because of the Russell 2000’s recent weakness, you can relax.
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