US small caps continue to underperform

Summary:

• US indices in the red before cash open

• Small caps continue to underperform

• US PP Y/YI: 2.6% vs 2.7% exp

After Tuesday’s session saw inside days for the major US indices, today’s could well prove pivotal. The question is whether the day’s trade represents a pause after the declines seen over the past week or whether it is a turning point for the markets. Today’s US session could well provide the answer. The US500 has pretty clear support and resistance levels on shorter time frames to keep in mind with recent lows of 2866 providing potentially key support and 2900 offering resistance. A break outside of these would end the consolidation seen so far this week and open up the possibility of a larger move.

After breaking lower on Friday the US500 has been in a 34-point range this week from 2866-2900. There have been several opportunities already to play this range by selling near the highs or buying around the low but a breakout is needed for a larger move. Source: xStation

While we have had some weakness in large-cap US indices lately, it should be pointed out that they are holding up pretty well relatively speaking. The US500, US100 and US30 all still trade within a few percent of their all-time highs whereas European bourses have dropped much further. Within the US it is interesting to note the underperformance of the small caps (US2000) in recent weeks compared to the large caps (EG US500).

There’s been a growing divergence between the small (US2000) and large (US500) cap stock indices in the US. A historically high level of leverage amongst the small caps could explain this in part, with rising yields presenting a greater risk to their performance going forward. Source: xStation

  One of the most plausible explanations for this is that smaller companies often carry higher levels of debt, and therefore the rise in yields is making this more expensive to service. The Russell 2000 (US2000 on xStation) currently has one of the highest net debt/EBITDA ratios seen in the past 30 years and well above its long run average. In contrast the S&P500 (US500 on xStation) is pretty much bang inline with its historical average. The Fed seem set to continue along their path of monetary tightening at a similar pace for the foreseeable future and even though President Trump commented last night that the Fed are hiking rates too fast, it seems unlikely he will try to intervene anytime soon.

Leverage amongst small cap stocks (Russell 2000) is well above the long run average while large caps (S&P500) is pretty much inline. Source: FT

It’s another light day for the economic calendar with the only US release of note being the latest PPI figures. The Y/Y reading of 2.6% is slightly below the 2.7% expected, but doesn’t represent a major miss. Tomorrow’s CPI is often more widely viewed and therefore holds a greater chance of moving the market.