SMALL CAPS MAY BE GETTING A LIFT FROM RISING FINANCIAL SHARES -- FINANCIALS ARE THE BIGGEST SECTOR IN THE RUSSELL 2000 -- AND HAVE BEEN THIS MONTH'S STRONGEST SECTOR -- WHILE HEALTHCARE WEAKNESS MAY BE HOLDING SMALL CAPS BACK

APRIL REBOUND IN FINANCIALS IS GIVING A BIG BOOST TO SMALL CAPS... I've been writing about the recent upturn in financial stocks and, to a lesser extent, small cap stocks. I also suggested that a stronger dollar might be helping smaller stocks. That's because a rising dollar usually favors domestic-oriented smaller stocks more than large multinationals whose exports become more expensive to foreign buyers. Another boost to smaller stocks may be coming from a recent resurgence in financial stocks. That's because financials are the biggest sector in the Russell 2000. Chart 1 shows the Financial Sector SPDR (XLF) clearing its 200-day average earlier this month before rising to the highest level in nearly seven months. Its relative strength ratio (solid line) started rebounding this month after underperforming for most of the past year. Chart 2 shows Russell 2000 Small Cap Index ($RUT) moving above its 200-day line this month by a much smaller margin. But April has seen stronger performance. Its relative strength ratio (solid line) is also starting to recover (but by a smaller amount) from potential support near its December low. The fact that both groups have started to do better (both on an absolute and relative basis) during April may not be a coincidence.

FINANCIALS ARE BIGGEST RUSSELL 2000 SECTOR... Financials account for more than 17% of the Russell 2000 and are its biggest sector. Other heavily represented small cap sectors are technology and healthcare (15% each), industrials (14%), and cyclicals (12%). Techs, industrials, and cyclicals have been market leaders this year, while healthcare has been the year's weakest sector. The recent upturn in financials may be the main reason for April's stronger small cap performance. An April drop in healthcare stocks may be the main factor preventing the RUT from doing even better.

FINANCIALS ARE POSITIVELY CORRELATED TO SMALL CAPS... Chart 3 directly compares the XLF to the RUT since last September's peak. Their close visual correlation isn't an illusion. Over those seven months, their positive correlation coefficent was .94 (upper box). Only the industrials matched that high number. Over the last forty trading days, the correlation between XLF and RUT at .83 is the strongest of the five largest sectors. Those numbers show a consistently strong linkage between financials and small caps. Over the past month, financials have been the market's strongest sector (8%); while cyclicals (7%), technology (6%), and industrials (5%) have also been strong. Healthcare, however, was the month's worst sector (-2%). Which suggests that financials have given small caps the biggest boost this month; while healthcare has been holding them back.

(click to view a live version of this chart)
Chart 1

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Chart 2

Chart 3