Small Caps May Be Breaking Out But Not All Are Created Equal

• The technical position of small caps in general
• Small cap sectors

The technical position of small caps in general

Small caps, as represented by the Russell 2000 ETF (IWM), have outperformed the market since late March and have now broken out in their own right. We can see this from Chart 1, where it is evident that the IWM has completed a small reverse head and shoulders. The KST has started to go flat, but has not yet triggered a buy signal by crossing above its MA. However, the more sensitive MACD has gone bullish, as it moved above its signal line earlier this week. The green arrows show that upside reversals in the MACD usually precede those for the KST. However, there is a price to pay for these leading characteristics. This is reflected by the false signals contained in the December 2017 ellipse, which the slower moving KST did not experience. It seems likely that the current MACD buy will evolve into a positive outcome for the KST because of the breakout in the price itself.

Chart 1

That’s important, because Chart 2 shows the critical nature of the current long-term technical situation. For example, the Special K, which you can read about here, is currently resting on its 2016-18 up trendline. This line also gains credibility due to its closeness to the red signal line. Should those benchmarks be violated, it would represent a major long-term momentum sell signal. In turn, that would suggest that the possibility of a violation of the 2016-18 up trendline should be taken seriously. Note that such action would likely be followed by a completion of a potential head and shoulders top as well. I am not saying this is going to happen, but is something we should be aware of. Such a scenario, would be completely negated with a daily close above the green horizontal line flagging the January high.

Chart 2

Chart 3 features a bar chart of the IWM. Once again, key support lies at the red trend line, which is also intersecting with the 200-day MA, at just under $148. If that line is breeched it would represent a major negative. Fortunately, thanks to the reverse head and shoulders breakout, the price is currently moving away from that line.

A more realistic current challenge for the IWM comes from the center window, which displays its relative line. The sharp rally since late March has grabbed the attention of a lot of observers, but it has yet to break above the 2016-18 down trendline. The KST for relative action, in the bottom window, is slightly overbought and in a declining mode. That means that an upside breakout, whilst not impossible, represents a real challenge until some of those relative gains can be digested.

Chart 3

My take from all this is that the IWM is just above key long-term support at a time when the Special K is in danger of breaking down. Most of the time these Special K setups work quite well. However, short-term we are likely to see a nice extension to the recent advance, which will hopefully take the price to a new high.

However, not all small caps move in tandem and some sectors can be expected to do better than others. The next few charts will outline some of these differences.

Small cap sectors

Chart 4 features the Dow Jones US Small Cap Growth Index ($DJUSGS), together with its relative strength line and relative long-term KST. This series broke above  the green resistance trend line last fall and corrected back to it a couple of times since. Since the long-term KST is positive and the price is above its 200-day MA, it is in a positive long-term technical situation. Most impressive of all, the RS line, in the third window has recently broken out from its 2015-18 base and is being supported by the long-term KST for relative action.

Chart 4

Another promising small cap area is consumer cyclicals, in the form of the PowerShares S&P Small Cap Consumer Discretionary (PSCD), as featured in Chart 5. The price is currently in the process of re-asserting its late 2017 breakout. Relative action suggests that a major reversal in fortunes is taking place since the two green trend lines have been penetrated on the upside. Moreover, the long-term KST for relative action is bullish and by no means overextended.

Chart 5

Their consumer staples counterparts do not look so promising. The PowerShares Small Cap Staples ETF, the PSCC, is in a positive trend, but its long-term KST certainly is not. Moreover, the relative line has been in a bear market for some time and remains below its red extended breakdown trend line.

Chart 6

The PowerShares Small Cap Materials ETF, PSCM, is in a positive trend and finding support at its extended green breakout trend line. My focus is more on the relative activity, which is right at a potential 2017-18 base. The long-term KST for relative action is edging its way higher, which suggests that the RS line will soon follow suit.

Chart 7

Finally, Chart 8 shows that the relative action for the PowerShares Small Cap Energy ETF, the PSCE is right at a 4-year down trend line. It’s KST for relative action has gone bullish, so there is a good chance of a relative breakout. When it comes to the absolute price we have a mixed picture as the KST and 200-day MA are bullish, but the price is still below its 4-year green down trend line. Since it has just broken out from a small base Chart 9), an attack on the line, at around $17, looks to be a good possibility.

Chart 8

Chart 9

Good luck and good charting,
Martin J. Pring

The views expressed in this article are those of the author and do not necessarily reflect the position or opinion of Pring Turner Capital Group of Walnut Creek or its affiliates.