The reflation trade both gives and takes away. Since last fall, this has been the situation for small-cap stock market investors in the United States, with a recent focus on the taking away.
The Russell 2000 RUT, -0.59 percent, the benchmark for small-cap stocks, was down 1.1 percent Thursday afternoon, on track for a 4.5 percent weekly drop, the sharpest since the week ending Oct. 30. Around that time, the Russell 2000 began a months-long run of outperformance as investors shifted away from so-called stay-at-home winners and toward stocks projected to benefit most from the economy’s reopening, buoyed by the rollout of vaccines and predictions for a strong economic reopening. That game stalled in the spring and hasn’t recovered since. The yield on the 10-year Treasury note has fallen dramatically from its peak near 1.80 percent to as low as 1.25 percent last week, flattening the yield curve and boosting large-cap stocks that are more sensitive to interest rates. The Russell 2000 is still up 10.5 percent for the year, but it is now trailing the large-cap Russell 1000 RUI, -0.35 percent, which is up 15.1 percent in the same time period. So far this year, the large-cap benchmark S&P 500 index SPX, -0.33 percent has gained 15.9%, while the tech- and growth-heavy Nasdaq Composite COMP, -0.70 percent has gained 12.6 percent and the large-cap tech-concentrated Nasdaq-100 NDX, -0.71 percent has gained 14.6 percent. So, how horrible is it exactly? The Russell 2000 struck a year-to-date low relative to the Russell 1000 on Wednesday, but it isn’t a complete washout, according to Kevin Dempter, an analyst at Renaissance Macro, in a Thursday note. Small-cap weakness has pushed the firm’s Russell 2000 trend model into neutral zone, he added, “which also mirrors our opinion on the index.” The index has maintained above an uptrend line built from the 2020 lows and above its 200-day moving average since rising in March. However, internal trends have deteriorated, according to Dempter, with only 62 percent of Russell 2000 items trading above their individual 200-day moving average as of Wednesday, compared to 80 percent in the Russell 1000. (see chart below).
Macro Renaissance
So, what would it take to go all-in on bearishness? It would need more internal deterioration and a break below absolute support, according to Dempter. “Until then, we’ll be playing this neutral outlook in small-caps by focusing on owning relative breakouts and leadership while cutting loose relative breakdowns,” he wrote, adding that pair-trading large-cap longs vs small-cap shorts could be an option./n
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