THE MARKET RALLY STILL FAVORS LARGE CAPS -- SMALL AND MID-CAP INDEXES ARE STALLED AT MAY HIGH -- SIX YEARS OF SMALL-CAP LEADERSHIP MAY HAVE ENDED

SMALLER STOCKS STILL HAVEN'T BROKEN OUT ... A lot has been said and written about the fact that the current market rally has been driven mainly by large cap stocks. So today's story isn't exactly new. It does, however, appear to support the idea that smaller stocks are lagging behind larger stocks for the first time in six years. Part of their short-term problem is shown in the first two charts. Chart 1 shows the S&P 600 Small Cap Index stalling at its May peak near 405. Chart 2 shows the same condition for the S&P 400 Mid Cap Index. Meantime, the S&P 500 Large Cap Index (not shown) is trading at a new six-year high. Even if both indexes of smaller stocks do eventually hit new highs, their underperformance may be more than a short-term phenomomen.

Chart 1

Chart 2

SMALL CAP RS LINE IS FALLING ... Chart 3 plots a relative strength ratio of the S&P 600 Small Cap Index (SML) divided by the S&P 500 Large Cap Index (SPX). The ratio is well below its May peak. It's also fallen below its 50- and 200-day moving averages. [Please see last Wednesday's article on applying moving averages to relative strength ratios]. Chart 4 shows a similarly weak RS line for the S&P 400 Mid Cap Index (MID).

Chart 3

Chart 4

SMALL CAPS RS LINE BREAKS MAJOR TRENDLINE ... Chart 5 shows the small cap/large cap ratio over the last ten years. The chart includes the six-year period of small cap outperformance starting in 2000. Small caps continued to do better than large caps until May of this year. It's what's happened since then that's so troubling. The chart shows that the SML:SPX ratio has broken a six-year uptrend line. [Although not shown here, the same is true for the MID:SPX ratio]. That strongly suggests that the six-year period of smaller cap dominance is ending.

Chart 5

SMALL CAPS ARE ALSO LAGGING MID-CAPS ... Chart 7 is a ratio of the S&P 600 Small Cap Index divided by the S&P 400 Mid Cap Index. Although the breakdown here isn't as obvious, the ratio is trading well below its spring and autumn highs. That suggests that small caps are doing worse than midsize stocks. That makes sense if the pendulum is swinging away from the smallest stocks. The message of each of the charts is to continue favoring the largest stocks. Having said that, any pullback in the small and midsize indexes from their May highs may cause some short-term profit-taking in larger stocks as well.

Chart 6