Some Unexpected Hot Spots Emerging

Posted by jbrumley on September 22, 2017 2:20 PM
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On Monday we took a look at some budding sector-based trends. Though they're difficult to trust simply because we're at a strange, mostly-bearish time of year and some of the previous new trends didn't pan out, at the very least we want to consider -- and handicap -- all possibilities that may lead to better trading opportunities.

Breaking the market's undertow into different sectors isn't the only way of figuring out where the hot spots are, however. We can derive similar value by looking at how each market cap and style (value or growth) segment is doing. And as it turns out, we're starting to see some real change on this front for the first time in a long time.

Just to ensure we don't overset the stage, most stocks -- regardless of their sector, style or market cap -- tend to move in tandem with the bigger market tide. If the market rolls over here, most stocks are going to roll over with it.

There's still value in dissecting the market into its most basic components though. One of those values is simply seeing which slivers of the market are most vulnerable to pullbacks or most likely to lead a recovery. Another benefit to this kind of analysis is spotting the bigger, overarching moves that supersede a short-term rally or short-term pullback.

Today's look is mostly the latter variety. We're seeing a segment of the market that's severely underperformed for months finally start to perk up. Though we suspect the broad market is setting up for something of a correction, this particular piece of the market is not only apt to lead the bounce, it may well defy the wave of selling that takes shape in the meantime.

That sliver is small cap value stocks. As the chart below illustrates, partially,  it's been lagging this year while everything else is in positive territory. Things have been dramatically different since mid-August though. The small-cap value composite has gained roughly 10%, while no other segment of the market has done better than a 3% gain. Yet, there's still plenty of room for small cap value stocks to keep reclaiming lost ground.

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What's most interesting is how these names don't seem to have hit the same headwind all other stocks ran into this week.

For more perspective on any particular move, we can zoom out to a longer-term look at the same style and market cap composites. It's usually this bigger-picture look that can and will negate a short-term clue, as from a longer-term perspective we can often see a short-term thrust is merely an unwinding of an overzealous move beforehand.

That's not the case this time around though. While small cap value stocks rallied indiscriminately in November and December of last year, that thrust was more than undone over the course of the first nine months of this year. Even with the recent rally, there's still long-term room for small cap value names to catch up with everything else.

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There's more.

Though we know that value has been a bit stronger than growth of late, and we know energy stocks have been performing better than most everything else, we can reasonably conclude that small cap energy stocks -- which are value stocks -- are doing the bulk of the driving for the emerging bullishness on the chart above. We don't know for sure though, and there may well be other small cap value slivers doing just as well. Here's the chart that answers the question.

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Sure enough, after a miserable start to 2017, small cap energy names are now heating up as the biggest winners. They're not alone though. Small cap financials (also categorized as value names) and small cap industrial names are really starting to roll... more so than other small cap segments anyway. Those are all new trends, and as such may have some longevity. (If you're color-blind, each segment's 12-month performance is listed next to its label on the key at the top of the image.)

Obviously there are never any guarantees, in life, or in trading. These things may all peter out before they get going in earnest, and as was noted, a marketwide bearish tide could kill these budding trends altogether.

On the other hand, stocks are stronger than others for a reason, and sometimes that's enough to defy the odds, and a headwind.

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