For the second day in a row small-cap stocks were aggressively sold while the DJIA was hitting new highs. Since the market close on Friday the DJIA is up about 1.2% while the Russell 2000 ETF (IWM) is down 2.36%. That level of disparity is very uncommon but typically it does revert fairly fast. The issue is whether it corrects due to a small-cap rally or a Dow Jones pullback.
Breadth was around 2-to-1 negative but what was most notable about the action was that bids simply disappeared for many smaller stocks. The number of stocks that fell more than 5% dwarfed the number that were up 5%. The market cap of the entire Russell 2000 is only about 10% of the S&P 500 so when selling hits the small-caps it has a much more profound impact.
So why is this happening? There isn't any obvious fundamental or technical reason. Small-caps aren't wildly overpriced compared to large-caps and they are definitely not more technically extended.
The primary answer to why this is happening is that for some reason computer algorithms and major funds have decided to rotate out of small-caps. The timing at the beginning of a new quarter is an indication that this a major portfolio reallocation. The amount of capital in pension funds is so huge that a slight shift in allocations can have a profound impact on small-caps.
While this action was quite painful for holders of small-caps the good news is that this sort of indiscriminate selling should lead to opportunities. Many of the stocks that are subject to wholesale dumping are strong fundamentally and will likely find interest as we head into third-quarter reporting season.
While the underperformance by small-caps is shocking it is not an indication that the market has major problems. It is primarily caused by giant funds reallocating their assets. They have decided to cut exposure to small-cap stocks for some reason. However, funds are not always very good timers, which is the positive spin on an ugly day.
Have a good evening. I'll see you tomorrow.