For the past 3 1/2 years, the small cap stocks have been leading the S&P 500 higher. How do I know this? Well let's go to the charts and take a look.
If you look at the 1st chart you will see a 4 year weekly chart of the Russell 2000 small cap index ($RUT). In the lower panel is a ratio line which is nothing more than $RUT divided by the S&P 500. If the ratio line is rising, that means small cap stocks are outperforming the S&P. If the ratio line is falling, that means small caps are underperforming the S&P.
You'll notice I have numbered all the significant swing points. If you compare the ratio line to the price chart, you will see how the ratio line confirms every move in the small cap index. $RUT makes a new swing high at point 3 and so does the ratio line. $RUT makes another new swing high at point 5, and so does the ratio line. This correlation between the two has been perfect until now. At point 9 the small cap index makes a new swing high (point 9 is higher than point 7) but the ratio line diverges for the first time making a much lower high. This means one thing and one thing only. Small cap stocks are no longer outperforming the S&P 500. So what will happen when the leader stops leading? I'll let you decide.
The next chart shows a daily 5 month chart of $RUT. Notice how the 50 day moving average has provided support for the small cap stocks since this rally began. Well on Friday the small cap index closed below the 50 day moving average for the first time. What does that tell you? Combine that with the message from the weekly chart I just spoke about and I think the message is clear. I'll let you reach your own conclusions.
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