Is It Time To Buy Small-Cap Tech?

From the desk of Steven Strazza @Sstrazza and Ian Culley @Ianculley

Thanks to everyone who participated in last week’s Mystery Chart.

We questioned whether this consolidation would resolve in the direction of the primary downtrend--in which case we would expect a break lower.

Or maybe buyers would step in and defend those former lows once again.

Despite the lack of bearish momentum readings, many of you wanted to sell on a break below support, citing the primary trend as a major deciding factor.

And that's basically where our heads were, too, as it's always easier to go with the trend.

So what are we selling? Or should I say... buying?

The chart was the Small-Cap Technology ETF $PSCT… but it was inverted!

So those who wanted to sell on a breakdown were actually buyers, and vice versa.

Here’s a fresh look at the chart, right side up this time:

It might not be too apparent at the index level, but small-caps have been improving.

And, to no surprise, the relative strength we're seeing further down the cap scale is in the same areas that are leading at the large-cap level.

Leadership is being driven by growth, with tech at the helm as usual.

So it would make perfect sense to see a similar course of events play out with small-caps, in which case tech would be the first area to break out and signal the next leg higher.

But that hasn't exactly happened yet.

Things have changed slightly since last week, as PSCT made a very slight new high but quickly retreated back beneath the breakout level. Price remains in a sideways range, as buyers weren't able to push past the February highs yet again. 

Notice how the recent performance in PSCT differs with the direction of its structural trend as well as that of its peer the Large-Cap Technology ETF $XLK.

Despite the underlying uptrend, PSCT has gone nowhere since Q1. Meanwhile, large-cap tech seems to make a new high every other day.

Bulls want to see small-caps break out of this base and confirm the new highs in large-caps. And if these small-cap leaders kick off a new leg higher, they could very well drag the Russell 2000 and the S&P 600 with them.  In that environment, the other sectors are likely heading back toward new highs as well.

But let's not get out over our skis here. This could very well be a failed breakout, in which case we definitely don't want to own PSCT.

On the other hand, with how sloppy this market environment is, it wouldn't surprise us one bit if it was just a false start and the current action turns out to be a bear trap.

As such, we want to be ready to buy some strong names within small-cap tech, so let's discuss a few of our favorite long setups.