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Thursday, May 2, 2013

Get Aggressive on Small Caps’ Weakness

Buying into the Russell 2000's sell-off should reward investors

The Fed maintained its program of buying $85 billion in bonds and stated that it could increase or decrease that amount. This is the first time that the governors have indicated a possible increase in purchases, and so this was viewed as an offset to talk by some Fed members of a possible decrease in buying before the end of the year.
In other economic news, ADP reported that 119,000 private-sector jobs were created in April, which is lower than the 150,000 expected. March construction spending declined 1.7% versus an expected increase of 0.7%.
At Wednesday’s close, the Dow Jones Industrial Average was off 139 points at 14,701, the S&P 500 fell 15 points to 1,583, and the Nasdaq was of 30 points at 3,299. The NYSE traded 721 million shares and the Nasdaq crossed 477 million. Decliners led advancers on the Big Board by 2.6-to-1, and decliners on the Nasdaq were ahead by 3.7-to-1.
There was much talk about the contrast between the midcap stocks, as represented by the Nasdaq chart, and small caps, illustrated by the Russell 2000 chart.

Trade of the Day Chart Key
The Nasdaq broke to new highs again this week, and Wednesday’s selling had little impact on the near-term trend. It merely cancelled Tuesday’s advance. The Nasdaq is in a powerful bull market with its first support line at 3,270, and more important support at the conjunction of the lines at 3,197 and 3,200. MACD is on a buy signal.
The major difference between the Nasdaq’s price action and Russell 2000′s is clear: The small-cap index has not followed through with a new high since early March, while the Nasdaq made a new high on Tuesday.
And on Wednesday, the 2000 failed to hold above its first important line of support, its 50-day moving average and support (now resistance) line at 930. Its MACD indicator is also on a buy signal.
Conclusion: Wednesday’s decline had no impact on the major indices. Even though the Dow had a triple-digit decline, that is probably attributable to the May Day holiday celebrated in most European countries and the resulting loss of potential foreign buyers.
With regard to the underperformance of the Russell 2000, investors are reluctant to become overly aggressive, thus the outperformance of the Dow and the S&P 500 versus the Nasdaq, and the better performance of the Nasdaq versus the Russell 2000. Small-cap stocks are considered more volatile, and so most investors consider them to carry more risk.
As the market’s bullish trend matures and confidence increases, more investors will be attracted to higher-risk stocks and the 2000 will sing. Buying now into the Russell’s current weakness should reward investors with higher gains later.
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