[Chart(s) Of The Week] The Small Chart With Big Implications

JC Parets
July 29, 2020

From the desk of Tom Bruni @BruniCharting

If you ask people what it would take for Small-Caps to begin outperforming you'll get a variety of answers. We need Financials to outperform. We need a weak US Dollar. We need a steeper yield curve. We need the moon to be in a waxing crescent. We need a miracle.

You'll have a lot of answers and a whole lot more confusion.

So in this post, we want to keep it simple and identify the two charts we're using to identify a sustainable turn in Small-Cap relative performance.

Let's start with the basics of index construction and ask what it would take for the Small-Cap 600 to begin outperforming the S&P 500?

At the very least, it would take the largest sectors of the S&P Small-Cap 600 (Industrials, Consumer Discretionary, Technology, and Financials) being in uptrends relative to their Large-Cap peers.

And how do we know this? Because if you create an equally-weighted Small-Cap version of those sectors and a Large-Cap version, then divide the two...here's the chart you get.

Click chart to enlarge view.

It looks exactly like the Small-Cap 600/S&P 500 (VIOO/SPY) ratio, which makes sense because the biggest sectors are going to have the biggest impact on both indexes' performance.

To reinforce this point, we've got a chart below of these sectors and their weighting in the S&P Small-Cap 600. Combined, they're 60% of the index.

And sticking with the "Keep It Simple Stupid" approach, let's see how these sectors are performing relative to their Large-Cap peers.

With the exception of Industrials, which are in a sideways range, all of these sectors are in relative downtrends. How could Small-Caps outperform in a meaningful way if their best players are underperforming?

The conclusion here is that until the Small-Cap versions of these sectors can start to outperform their Large-Cap peers, the entire S&P Small-Cap 600/S&P 500 ratio is likely to continue its downward trend.

That's not to say we're not at a potential inflection point. Who knows, maybe we are, maybe we aren't. But from a long-term perspective (and in our cap-weighted world), Small-Caps have a lot of work to do before we can say they're ready to outperform over a multi-quarter/multi-year timeframe.

That's the way we're looking at this situation, but what do you think?

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Allstarcharts Team

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