Small caps just flashed a warning sign.
The IWM Russell 2000 ETF, which tracks small-cap stocks, just entered a death cross where its shorter-term 50-day moving average moved below its longer-term 200-day moving average. This typically marks a quickly decelerating trend.
The last time it entered a death cross, in November 2018, the IWM ETF fell more than 20% within two months.
Ari Wald, head of technical analysis at Oppenheimer, isn’t waving a red flag yet.
“It’s really not about small cap underperformance. It’s really been about large cap outperformance,” Wald said on CNBC’s “Trading Nation” on Monday. “The fact that small caps are lagging, I don’t think it is a worry, but they do have to participate. They have to stay afloat.”
The Russell 2000 index has fallen 5% in the past three months, a deeper decline than the 2% drop on the broader S&P 500.
As for the death cross, Wald says to ignore that technical move in favor of a more positive sign.
“We got a new bullish inflection in that 200-day moving average for the first time in a year. I see that as a positive,” he said.
Mark Tepper, president at Strategic Wealth Partners, says the timing of small-cap weakness is most important as an indicator for the broad market.
“If we were three years into a bull market, and small caps are underperforming like this, I’d be really concerned. But we’re almost 11 years in, so I’m not as worried because this is what happens. Small caps tend to underperform in the later innings of these long secular bull markets,” Tepper said during the same segment.
There are a few reasons for this, he says. First, small-cap stocks tend to be more highly leveraged and therefore more susceptible to economic downturns. The fact that a large number of the stocks are in the financials or industrials sectors also accounts for weakness during slowdowns.
“Beyond that all the best performers from the small caps [during bull runs] have now reconstituted into mid-cap. So you’re left with just the laggards,” Tepper said. “At this stage of the game, I’d much rather be in large cap over small.”
The Russell 2000 has added nearly 40% over the past five years, while the S&P 500 is up more than 50%.