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Chart Advisor: Small Caps Extend

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Tuesday, January 12, 2021

1/ Russell 2000 surges as large cap indexes stay rangebound 

2/ Energy sector stocks continue strong trend higher 

3/ Airline stocks leveling off 

4/ The bottom line

1/ Russell 2000 Surges, Large Cap Indexes Stay Rangebound  

The large cap benchmark indexes traded in a tight range today, but that doesn’t mean investors weren’t interested in putting money to work. Small cap stocks moved strongly higher closing near the high of the day’s session.  

The chart below displays an hourly comparison of Invesco’s Nasdaq 100 ETF (QQQ) and iShares’ Russell 2000 ETF (IWM) since the beginning of the year. The chart displays a growing trend of relative strength for the small cap index in comparison to its tech-heavy counterpart. The lower panel of the chart shows what the Nasdaq index looks like if it were priced in units of the Russell index instead of being priced in dollars. This illustration shows the dramatic loss of relative value in the Nasdaq that has been happening since the beginning of the year.  

The reasons for this are likely connected to two items. The first is the expectations of the impact of stimulus and economic normalization in a post-COVID world—which investors seem increasingly willing to bet on. The second may be a less cheery idea that includes the notion that when long-running bull markets begin to approach a top, investors show a willingness to seek out riskier investments. As more established companies begin to offer less and less opportunity for unusual growth, investors begin to seek companies with greater future potential. Astute chart watchers will want to keep an eye on this comparison over the months ahead. 

2/ Energy Sector Stocks Continue Strong Trend Higher 

Another collection of stocks that surged higher today was found in the energy sector. The chart below compares State Street’s energy sector index ETF (XLE) with some of its top components including: Chevron (CVX), EOG Resources (EOG), Schlumberger (SLB), ConocoPhillips (COP), and Phillips 66 (PSX). All of these stocks are up strongly since the first of November. The recent surge in oil prices has given the trends of these stocks a new catalyst to move higher.

3/ Airline Stocks Leveling Off  

Over the past few decades, a well-worn investing maxim was that airline companies and transportation stocks were inversely correlated with the price of oil. As oil and energy prices increase, so would the costs of operation increase within such companies, and naturally the profit margins of these operations would decrease.  

But in a world where aggregate demand was so dramatically affected by an unprecedented pandemic, investors had to try to estimate the ultimate value of such companies using little more than an optimistic guess. If the world would re-open for business, then travel would do well; if not, the industry would languish—or so the oversimplified thinking went. Since the price of oil became the most available proxy for the future of consumer demand, then for a time airline stocks and the price of oil were positively correlated.  

But since the beginning of 2021 that no longer seems to be the case as the charts below demonstrate. Delta Air Lines (DAL), United Airlines Holdings (UAL) and Alaska Air Group (ALK) all show a common pattern since November: an initial surge and subsequent pullback in price. It’s anyone’s guess whether travel this summer will revitalize these companies, but for now investors continue to guess. Today, it seems, they like their chances.

4/ The Bottom Line 

While larger company stocks traded nearly unchanged in a tight range, small cap stocks made a dramatic move higher. This is likely bullish in the short term. Energy sector stocks also surged higher today but didn’t dampen the prospects of air travel companies.

Originally Published on January 12 , 2021

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