Trend Check with Tushar Chande

Small Cap Stocks Show Significant Weakness


Small cap stocks have broken down in a noteworthy way, as the down-move I anticipated roils the market. Typically, weakness in small cap stocks is an early warning of weakness in their larger cousins.  First, a majority of stocks in the S&P 600 Small Cap Index have turned lower in all four of my trend following models (see Chart 1).  Second, $SML, the Small Cap index has broken below its 200-day simple moving average (see Chart 2).  Third, the broader Russell 2000 Index has also reached its 200-day simple moving average (see Chart 3).  All three, taken together, point to significant weakness in the small cap area.  Now, the question is whether the weakness will spread elsewhere.

Chart 1: All four of my trend-following models show a majority of stocks in the small cap index trending lower, which means the underlying small cap universe is turning lower.  These calculations are supported by charts 2 and 3 below.


Chart 2: The S&P Small Cap Index dipped below its 200-day simple moving average, an additional sign of weakness in this sector. (A live version is here.)


Chart 3:  The broader Russell 2000 index has just retreated to its 200-day moving average, suggesting weakness in the broader market. (A live chart is here.)


Tech Stocks in Key Support

The Nasdaq Composite index has reached critical support near its 65-day simple moving average. During this up-trend, these stocks have bounced at or near the 65-day average.  Hence, we just need to track if this pattern repeats, or is reversed, for clues to the next move in this market.


Chart 3: The COMPQ has found support at or near the 65-day simple moving average.  So a bounce or breakdown from here will provide clues to future direction. (A live version is here.)


US 10-Year Yields Fall Below 200-day Average

With scant signs of inflation, the US 10-Year Treasury Yield has now fallen decisively below its 200-day average and looks set to test its June lows.  Naturally, a risk-off move driven by recent headlines has also helped.  If the 10-year yields fall below the June lows, it will add to concerns about the stock market.

Chart 4: The risk-off trade is alive and well, and the US 10-year yield appears ready to test its lows from June.  A slide below the June levels will raise concerns about the health of the stock market. (A live chart is here.)

VIX Rises to Critical Down Trend Level

The $VIX index, a measure of fear and volatility, has just tested its recent down-trend line.  It is likely that a strong push above this trend-line will be needed to form a reliable market bottom if the down-trend of the past few days is to continue. Observe how quickly the VIX was able to rise to the trend-line, implying that it will be easy to expand the VIX past the down-trend line.


Chart 5: The VIX index expanded very quickly to its trend-line from the January 2016 lows.  A break above the trend line seems to in the cards, and will probably be needed to form a good low if the current move continues. (See live chart here.)


Sell-off in SPX Nears Key Level

The percent of stocks above their 50-day moving average in the S&P 500 universe has dropped to a key support seen in the recent up-trend (See Chart 6 below).  A drop below 40% would take it down towards the levels just before the presidential election.  Thus, the SPX internals are at a key level, where one can expect at least a small bounce.


Chart 6: The percent of stocks in the $SPX universe above their 50-day moving average has dropped to key support levels seen earlier in the trend.  A breakdown here will take it into weakness not seen since before the election. (A live version is here.)

Down-side Targets for the Dow

It is easy to spot potential support zones as the Dow moves lower.  I have marked the approximate percent retracement to the top of each support zone for quick reference.  Since a 5% correction seems to be the preferred talking point, a trip down to the 21,000 level in the Dow would be needed to satisfy these traders.

Chart 7: Support zones for the Dow 30 are easy to see on the chart, and I have shown the approximate precent decline to the top of the support zone.  A move down to 21,000 would be relatively easy, but a move below 20,400 would need some outside drivers.  The medium-term trend is still green. (See live chart here.)



The weakness in Small Cap stocks bears close scrutiny, since it may be an early warning of more weakness to come in their larger cap cousins.  The percentage of stocks above their 50-day average in the S&P 500 universe are also at key support, along with the COMPQ index.  Thus, the market is testing important support areas.  The Dow 30 support chart gives a handy reference for measuring declines for the immediate future.

John Murphy discussed the weakness in small caps earlier in the weak here.  Tom Bowley discussed Nasdaq 100 ($NDX) support levels here.

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Tushar Chande
About the author: , PhD, MBA, is the inventor behind an impressive collection of technical indicators, including the Aroon and Stochastic RSI. He has written several books, holds both a PhD in Engineering and an MBA in Finance, and has over two decades of experience trading the financial markets. Follow Tushar in this blog as he highlights his new "Trend Meter" indicator and shares his analysis of current market conditions. Learn More
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