Will small cap stocks lead the way?
Thursday’s market saw the small cap stocks, as measured by the Russell 2000 i-Shares
(
IWM |
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PowerRating), down over a percent while the S&P 500
(
SPY |
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PowerRating) large caps were down less
than half a percent. As I have chronicled on my
website, this underperformance of small cap stocks has persisted for a
number of days. As we shall shortly see, however, figuring out what that
might mean for the future is a tricky affair.
On a day-to-day basis, the small caps seem to influence large cap
performance. Going back to January, 2002 (N = 995 trading days), I found
184 days in which the S&P 500 (SPY) was down less than half a percent.
The next day, SPY averaged a gain of .05% (104 up, 80 down). When,
however, IWM was down a percent or more on the modest down day for SPY (N = 30),
the next day in SPY averaged a loss of -.15% (13 up, 17 down). When IWM
was up for the day when SPY was modestly down (N = 60), the next day in SPY
averaged a gain of .17% (35 up, 25 down).
What this suggests is that modest selling in SPY is more likely to be
followed by weakness the following day if the broad market of stocks is weak
than if the broad market is firm. Indeed, when IWM was up
more than half a percent when SPY was moderately down (N = 20), the next day in
SPY averaged a gain of .47% (12 up, 8 down).
Interestingly, however, the spillover of Russell relative strength/weakness
tends to dissipate after that next day of S&P trading. It is a
short-term effect. In fact, when I analyzed eight day periods of
relative IWM weakness vs. SPY on my
research site, I found that such weak periods led to future eight-day
outperformance
by the large caps. In other words, the pattern that we see in the
short-run–broad market strength or weakness spilling over to the next time
period for large caps–does not seem to apply to longer time frames.
It is human nature to not only look for patterns, but to assume that the
patterns we find will be generalizable across a variety of time frames and
trading instruments. My analyses suggest that this isn’t necessarily
so. Many of my cherished market assumptions have died a humble death when
they’ve undergone this kind of historical scrutiny!
Brett N. Steenbarger, Ph.D. is Associate Clinical
Professor of Psychiatry and Behavioral Sciences at SUNY Upstate Medical
University in Syracuse, NY and author of The
Psychology of Trading (Wiley, 2003). As Director of Trader Development
for Kingstree Trading, LLC in Chicago, he has mentored numerous professional
traders and coordinated a training program for traders. An active trader of the
stock indexes, Brett utilizes statistically-based pattern recognition for
intraday trading. Brett does not offer commercial services to traders, but
maintains an archive of articles and a trading blog at www.brettsteenbarger.com
and a blog of market analytics at www.traderfeed.blogspot.com.
He is currently writing a book on the topics of trader development and the
enhancement of trader performance.