Small Cap Divergence
The S&P 500 Index and the Dow Jones Industrial Average, two groupings of large cap stocks, are not far from their March 1st all-time highs following Trump’s calming speech to Congress. The Russell 2000 Small Cap Index (IWM) has lost momentum and has drifted sideways to down from early December 2016 through today - the Russell Midcap Index (IWR) is splitting the uprights.
One way to interpret this is smaller cap stocks are consolidating gains after running 20%+ since the US presidential election. Another way to interpret this is as an indication that the risk appetite of investors in waning. Small companies are considered riskier investments than large cap companies. When small cap stocks under perform large cap stock on a relative basis, many market analysts believe the risk premium of the market is rising and investors are becoming increasingly cautious.
A declining risk appetite generally equates to a declining stock market. A negative divergence between small and large cap stocks is often an early warning signal. On the other hand, there are times when the market pushes through a period of investor anxiety measured by small cap under performance without incurring much damage.
In 2014, the S&P 500 Index appreciated 13.5% while the Russell 2000 small cap index advanced only 5%. The following year, the S&P 500 traded sideways making a small gain with dividends of about 1.3% while the Russell 2000 lost -4.5%.
What has not been featured in the headline news is the loss of momentum over the past several months of smaller stocks. This development is of note and causes us to even more closely stick to our discipline of using non-emotional, time-tested measures to make investment allocation decisions including the Leading Economic Index and Treasury Yield Curve. We end this week with a continued bullish stance but respectful that market conditions may be entering a transition period.
Now More Than Ever
The bull market is eight years old. In 2016, $625 billion was invested in passive index funds. $92 billion was withdrawn from actively managed funds. There has been a mega-trend away from actively managed funds into indexed, passive type funds. When anything gets this one-sided, one has to start thinking about taking the other side, going against the herd.
We are in the second longest bull market in history. There is a rising probability that the crowd has arrived to the party late. The purchase of S&P 500 and other major index funds works well when stocks are rising. This approach does not offer protection during bear market periods.
Now, more than ever you need a money manager equipped with disciplined, non-emotional tools to reduce equity exposure when the risk of a bear market rises. The day that you want to greatly reduce your equity holdings and be protective of your wealth is nearing the longer the bull market extends.
The truth is, most actively managed funds do not significantly reduce equity exposure during bear markets. Many actively managed funds were down as much if not more than the S&P 500 in 2008.
If having a plan to protect your wealth from the next major bear market is important to you, give us a call or send us and email to discuss how we can be of service.
One of the keys to investing is sifting through all available information and sticking to a plan. Somehow, we need to control our emotions about something that is very important to each of us. We invite you to call or email anytime if you have questions about how we can help you with your wealth management. Please give us a call at (415) 249-6337 or email us at email@example.com to learn more..
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This commentary and a sampling of previous editions are available as PDFs:
3/10/2017: Small Cap Divergence
3/3/2017: Velocity Pivot Good for Stocks
2/24/2017: How Safe Are The Banks
2/17/2017: Climbing A Wall of Worry
2/10/2017: Value Shopper - Europe on Sale
2/3/2017: What, Me Worry
1/27/2017: Extraordinary Earnings Louder Than Trump
1/20/2017: It's Not All About Trump
12/30/2016: Predicting the Future -2017
12/2/2016: Trade What Is, Not What You Think It Should Be – 2017 Outlook
Pursuant to the provisions of Rule 206(4)-1 of the Investment Advisors Act of 1940, we advise all readers to recognize that they should not assume that recommendations made in the future will be profitable or will equal the performance of past recommendations. This publication is not a solicitation to buy or offer to sell any of the securities listed or reviewed herein. The contents of this letter have been compiled from original and published sources believed to be reliable, but are not guaranteed as to accuracy or completeness. Nicholas Atkeson and Andrew Houghton are also principals of US Capital Wealth Management, a registered investment advisor. Clients of US Capital Wealth Management and individuals associated with US Capital Wealth Management may have positions in and may from time to time make purchases or sales of securities mentioned herein.
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