Diary of a Financier

Small cap buying opportunity

In Capital Markets, Trading Desk on Tue 23 Sep 2014 at 10:08

I’ve been monitoring the internal correction, which has Small Caps ($IWM) -2.5% ytd with the average stock in the Russell 3000 ($IWV) in a full-blown bear market — despite Large Caps ($IWB) being +8% ytd.  My multidisciplinary analysis yields a buy signal for IWM…

Fundamentals/quant

A historical analysis of relative returns gauges my expectations for IWM’s future path.  The period of Small Cap underperformance we’ve currently experienced is in the 5th percentile of all 3-month rolling periods.Quant study_Small Cap vs Large Cap relative performance distributions (3 month rolling, 1979-2014) Subsequent to such sizable divergences, IWM historically outperforms IWB per the following averages:

T+3mos* = par
T+6mos = +2% (outperformance)
T+12mos = +4% (+10% outperformance ex-Tech Bubble)
*You are here

In addition, relative value analysis say Small Caps are now compellingly cheap compared to other sizes, especially when valuation multiples are normalized by growth rates (i.e. PEG):

Quant screen_Equity index valuations by size & country 2014.09.22

Quant screen_Equity index valuations by size & country 2014.09.22

 

Technicals

The IWM/IWB ratio @ 1.01x is at its lowest level since 2/2010, when markets were starting to recover from the crisis:

IWM vs IWB 2014.09.23

According to the charts, Small Caps on their own may have some limited short term downside before hitting 1st support at IWM’s daily ST bull pennant trendline support >$111 (-1.2%), but that pattern — along with an overarching LT consolidation channel — present a bullish backdrop for the intermediate term.  I am, however, monitoring the key technical risk in weekly 3x bear divergence:

IWM daily/weekly 2014.09.23

~~~~

We renewed our position in IWM @ $112 this morning, starting with a 2% allocation.  I will add to that stake per the following expectations:

  1. If IWM’s daily bull pennant trendline support >$111 holds
  2. Otherwise, I’ll reassess at IWM’s daily LT consolidation channel support @ $107.25

Our portfolio’s statistics are as follows:

Asset allocation (stocks/bonds/cash): 62/30/8 vs 60/40 benchmark
Beta (β): 0.75 vs 0.76 benchmark
Sigma (σ): 0.89 vs 0.62

–Romeo

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  1. Counterpoint…
    SPX/IWM ratio at 2 year lows | JC Parets (All Start Charts)
    “[SPX/IWM ratio] momentum was putting in a bearish divergence at those new highs in March. RSI is now hitting oversold conditions which puts this momentum indicator in a bearish range. All signs are pointing to lower levels in this ratio and I see little reason to like Small Caps here, particularly on a relative basis.”

    http://allstarcharts.com/small-caps-hit-2-year-lows-vs-large-caps/

  2. […] At or near record levels for all categories, which is astounding given the small cap “internal correction”; SPX didn’t crash until 3-5 months after real margin debt peaked in 2000 & 07, at which […]

  3. […] watch: daily LT bull flag near trendline sppt < $106; weekly 4x bear divgce. $RUT thebuttonwoodtree.wordpress.com/2014/09/23/sma… 2014.10.09 @ […]

  4. […] At or near record levels for all categories, which is astounding given the small cap “internal correction” & energy selloff; this margin bubble will pop as we come closer to rising Fed Funds Rates […]

  5. […] Retracing from record levels at a steady, healthy pace, which is astounding given the small cap “internal correction” & energy selloff; hopefully the trend continues so this margin bubble doesn’t pop as […]

  6. […] in retracement from record levels; resilience of leverage is astounding given the small cap “internal correction” & energy selloff ytd, but hopefully the steady, healthy moderation continues so this margin […]

  7. […] in retracement from record levels; resilience of leverage is astounding given the small cap “internal correction” & energy selloff ytd, but hopefully the steady, healthy moderation continues so this margin […]

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