Let's Hear it for the Little Guys

Growing up in Miami I obviously played baseball. This is what you do there. I was a pitcher but never threw very hard. This made things more difficult for me. So whether it was throwing curve-balls and change-ups to throwing pitches when the hitter was in the box and not looking, to the "balk move" to first, I had to look for any advantage that I could find.

When it comes navigating the stock market, I've learned that I have to do the same thing. Again, I find myself looking for an edge. One thing I've picked up on is that when the small-caps are outperforming large-caps, the big players that move markets are Bullish and feel the need to speculate on smaller-cap companies whose stock prices will theoretically grow faster than the bigger, already-established companies. If worried about the market, they would rather keep their money in "safer" Large-Cap names that should hold up better in a market decline.

I like to keep things simple, so lets take the IWM:DIA ratio and put it over the S&P500 Index (let's use SPY to keep the ETF theme). Looking back, this small-cap to large-cap ratio has been a great indicator for the S&P500's direction. When SPY made new highs in the fall of 2007 and the IWM:DIA was making new lows, we knew there was trouble in paradise. On the flip side, when the S&P500 was making fresh lows in early 2009 and the IWM:DIA was making a "higher low" we knew that this was NOT the end of the world and the S&P500, contrary to popular belief at the time, was NOT going to zero.

[caption id="attachment_64" align="aligncenter" width="620" caption="Russell2000 vs DJ Industrials(Red) & S&P500(Blue)"][/caption]

Well sure enough, the IWM:DIA has been leading us to all of our new highs ever since those cold Manhattan winter days in early 2009. So lets take a step back and look at this ratio without the SPY behind it, without moving averages, without any noise but pure price action. It looks to me like this .68-.69 level is awfully important resistance. Take away the false move in early '06, and it appears like this is THE level of resistance. (that false move led to a very fast move in the opposite direction and we'll talk about that in a future post. you guys aren't ready for that yet)

The IWM:DIA is a very important ratio to me and we'll be watching this closely as it has been tracing out a very typical continuation pattern that most of you are familiar with. Small Cap vs Large Caps are testing this level of resistance now for the 6th or 7th time. A clear breakout above 0.70 should bode well for US Equities.

[caption id="attachment_65" align="aligncenter" width="619" caption="Russell2000 vs DJ Industrial Avg Inverse H&S"][/caption]

Let's hear it for the little guys!