Last week in our note to Institutional Clients we highlighted the potential for mean-reversion in the relative performance of Small and Micro-Caps, driven by rotation into Financials and Healthcare.
Below is a chart of the Micro-Cap Index (IWC) relative to the S&P 1500, confirming a failed breakdown and bullish momentum divergence. As long as prices are above 0.1405, this ratio looks ripe for some mean-reversion to the upside.
Click on chart to enlarge view.
Same goes for the Russell 2000 relative to the S&P 500, failing to hold its new marginal low as momentum diverges.
Here's the Russell 2000 breaking out of a 2 month long base on an absolute basis as well. For the first time in a while, our risk is very well-defined on the long side vs ~158.
If Small and Micro-Caps are going to outperform, these are the conditions that are going to spark it. On the other hand, prices rolling over and this mean-reversion failing likely occurs in an environment where Large-Cap stocks fail at their all-time highs and correct further through time or price.
So not only is this a tactical trading opportunity, but an important inter-market signal about risk appetite that we're watching.
As with our other premium posts from the last few weeks, we want to be in the strongest names where our risk is extremely well-defined and earnings are either out of the way or far out enough to give the trade time to work and build a cushion into the event.
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