Investing stocks abstract image

Relative Strength Investing Trends: Small Caps on the Rebound

Relative Strength Investing Trends: Small Caps on the Rebound

Small cap stocks have shown strong signs of life in recent months after lagging large caps for the first part of 2020 and for much of the last several years.  This edition of our High RS Trend Report takes a look at this development in small cap stocks as well as provides an update on all of our key relative strength indicators.

What’s Hot…and Not

How different investments have done over the past 12 months, 6 months, and 1 month. Never before has it been easier for investors to invest in the strongest trends wherever they might be found in the world due to the global nature of financial markets. Relative strength offers a disciplined framework for allocating among those trends.  Markets are global and your portfolio should be too.  As of 11/13/20:

Asset Class Performance

Past performance is not indicative of future results.

See disclosures in Appendix A, which includes the ETFs and Indexes used for this performance table. Performance numbers include dividends but do not include all transaction costs. Investors cannot invest directly in an index. Indexes have no fees. Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss.

Fund Flows

Total estimated inflows to long-term mutual funds and net exchange traded fund (ETF) issuance collected by The Investment Company Institute.

Net New Cash Flow

See disclosures in Appendix A.

Sector and Capitalization Performance

Sector Performance | Capitalization Performance

Past performance is not indicative of future results.

See disclosures in Appendix A.

High RS Diffusion Index

As of 11/13/20:

High RS Diffusion Index

The 10-day moving average of this index is 61% and the one-day reading is 63%. This index measures the percentage of high relative strength stocks (top quintile of the ranks), which are trading above their 50-day moving average.

See disclosures in Appendix A.

Relative Strength Spread

The chart below is the spread between the relative strength leaders and relative strength laggards (universe of mid and large cap stocks). When the chart is rising, relative strength leaders are performing better than relative strength laggards. As of 11/13/20:

RS Spread

The RS Spread has been particularly volatile in recent weeks as we have received a flurry of news on the development of a vaccine.  Whether or not we see a sustained moved in the relative strength laggards remains to be seen.  By design, relative strength strategies are adaptive and will continue to incorporate each day’s price action into the rankings in order to identify both those stocks with sustained strength and those stocks with sustained weakness.

See disclosures in Appendix A. 

Small Caps on the Rebound

Small cap stocks have shown strong signs of life in recent months after lagging large caps for the first part of 2020 and for much of the last several years. The WSJ provided a summary of some of the recent strength in small cap stocks in Big Gains From Small Stocks Power Russell 2000 Surge published on 11/15/20An excerpt is below:

Shares of small companies are posting outsize gains, driven by investors’ bets that a rebounding economy and expected Biden administration policies will boost profits at smaller U.S. companies.

The Russell 2000 index of small-company stocks rose 6.1% last week, hitting its first record close since 2018 and extending a recent race ahead of other major indexes. It finished the first two weeks of November up 13%, its best 10-session start to a month on record, according to Dow Jones Market Data. The broader S&P 500 gained roughly 9.6% in that period.

That marks a reversal from earlier in the year, when shutdowns hammered shares of small-cap companies, which tend to have fewer business lines and a greater reliance on the domestic economy than larger, diversified peers. The Russell 2000 lagged behind the market rebound and has now gained roughly 4.5% in 2020, according to FactSet data, compared with 32% for the Nasdaq Composite and 11% for the S&P 500.

The relative strength chart below compares the Russell 2000 Small Cap Index to the S&P 500 Large Cap Index. When the chart rises in a column of X’s it is reflecting the outperformance of small cap stocks. 

alt text

Source: Nasdaq Dorsey Wright, as of 11/13/20. Price returns only, not inclusive of dividends or expenses.

For perspective on the year-by-year performance of the Russell 2000 (RUT) and the S&P 500 (SPX) since 2005, please see the table below.  As reflected in the table, the Russell 2000 has only outperformed the S&P 500 once 2013.

alt text

Source: Nasdaq Dorsey Wright, as of 11/13/20.  Price returns only, not inclusive of dividends or expenses.

If this trend of outperformance of small cap stocks continues it would mark a significant change from what has largely been in place for years—the trend of outperformance by large cap stocks.

The relative strength strategy is NOT a guarantee. There may be times where all investments and strategies are unfavorable and depreciate in value. Relative Strength is a measure of price momentum based on historical price activity. Relative Strength is not predictive and there is no assurance that forecasts based on relative strength can be relied upon to be successful or outperform any index, asset or strategy.  In all securities trading there is a potential for loss as well as profit.  It should not be assumed that recommendations made in the future will be profitable or will equal previous performance.  Investors should have long-term financial objectives.  Past performance, hypothetical or actual, does not guarantee future results. In all securities trading there is a potential for loss as well as profit. It should not be assumed that recommendations made in the future will be profitable or will equal the performance as shown. Investors should have long-term financial objectives.  Advice from a financial professional is strongly advised. 

Other Relative Strength Sources

  • Brush, John S. "Eight Relative Strength Models Compared." Journal of Portfolio Management (1986).
  • Berger, Israel, Moskowitz. "The Case for Momentum Investing." AQR Capital Management. 2009.
  • Jegadeesh and Titman. "Returns to Buying Winners and Selling Losers." Journal of Finance (1993).
  • O'Shaughnessy, James P. What Works on Wall Street. McGraw Hill, 1997.

Other Topics

Indexes

MarketInsite

Nasdaq

Nasdaq’s Marketinsite offers actionable insights on a variety of market-moving topics. Learn from our thought leaders who are driving the capital markets of tomorrow.

Read MarketInsite's Bio

Nasdaq Dorsey Wright

Nasdaq

Nasdaq Dorsey Wright is a registered investment advisory firm with more than 30 years of expertise is technical analysis, specifically focusing on the steadfast relationship between supply and demand in the markets. Our research and tools help our clients see through the day-to-day clutter of market movements while providing a clear understanding of where market strength lies at all times.

Read Nasdaq Dorsey Wright's Bio