Are Small Cap Stocks Undervalued?

Above is a 2 year daily chart of the ETF for the Russell 2000 (IWM). Below that is a ratio chart of the russell 2000 divided by the dow jones industrials.

Over the past two months the dow jones industrials have been stronger than the NASDAQ, S&P and the small cap stocks. Clearly the small cap stocks have been lagging the overall market especially when compared to the dow. You don't have to take my word for it, just look at the ratio line in the lower pane and you will see that this line is at the lowest level in two years.

What's interesting about this ratio line is that when it gets down to a low level (red line) it appears money begins to flow into small cap stocks and a rally follows. I placed a red arrow whenever the ratio line moved below the red line. As you can see that marked a buying opportunity in small cap stocks just about every time.

You'll also notice IWM broke out to new highs yesterday on very heavy volume and the ratio line is now turning up. Does this mean the stock market will continue higher? Will money begin to flow into small caps and out of dow stocks? If you ask me this market looks overbought and vulnerable for a sharp down move...but I can't let my subjective evaluation get in the way of my trading. If I see an undervalued or lagging sector moving higher on volume, I'm a buyer and that is why I bought IWM this morning with a protective stop below yesterday's low.