Small caps still show technical strength

While economic news could trigger a correction, the mid-term trend for small-cap stocks remains positive.

By Feb 2, 2012 3:22PM
Image: Stock market (© Zurbar/age fotostock)By Tom Aspray,

Disappointing jobs figures and other signs of economic weakness may have been enough of the "bad news" I have been looking for since last week. 

Wednesday's ADP employment report showed 170,000 new jobs were created in January. The increase was less than forecast and followed a downward revision of the December figure. Meanwhile, the American Association of Individual Investors (AAII) sentiment survey shows the bullish percentage dropping from 48.4% to 43.8%, and the number of bears jumping by 6%. The market now seems to be holding its breath ahead of Friday's monthly jobs report.

Though a drop below Monday's lows would suggest a deeper and more complex correction, the analysis of the advance/decline (A/D) lines for the major averages is still positive for the intermediate term.

The new leadership role of the small-cap stocks, as measured by either the iShares Russell 2000 Index Fund (IWM) or the iShares S&P SmallCap 600 Growth Index Fund (IJT) is also a positive sign. These small-cap indices were up over 2% on Wednesday as compared to a less-than-1% gain in the S&P 500.

Click to enlarge

Chart Analysis: The daily chart of the iShares Russell 2000 Index Fund (IWM) was finally able to overcome the 61.8% Fibonacci retracement from the April 2011 highs on January 18. Wednesday's close above the $80 level indicates a test of chart resistance in the $83 area, line a.

  • IWM made highs of $85.97 in July and $86.81 in April. The high in 2007 was $85.74
  • The break through the resistance at line d has turned the relative performance, or RS analysis, positive, thus indicating that small caps are outperforming the S&P 500
  • The break of the uptrend, line e, in late 2011 was indeed a fake out
  • Weekly RS analysis (not shown) is also now positive
  • Daily on-balance volume (OBV) completed its bottom formation in October when it moved through initial resistance (line g) after failing to confirm the lows; this resistance (now support) was retested in December
  • The OBV has now moved through the new resistance, line e, confirming the price action
  • Initial support for IWM now stands in the $78.50-$77.50 area

The PowerShares QQQ Trust (QQQ) overcame the 127.2% Fibonacci price projection target at $60.89 on Wednesday as well as the equality target at $60.54 that was derived using the 2002-2007 rally.

  • The upper trend line resistance, line a, is now in the $63.60 area
  • The Nasdaq 100 A/D line broke its downtrend, line d, on December 23 and then surpassed the July highs (line c) last week
  • After a slight pullback, the A/D line has again turned higher; it is well above its rising weighted moving average (WMA)
  • There is now initial support for QQQ at $60.30 with further support at $59.25-$59.50 and the rising 20-day exponential moving average (EMA - in red)

The Spyder Trust (SPY) has tested its 127.2% Fibonacci price target at $133.39 (the high on Jan. 26 was $133.40) but has not closed above it.

  • The next major hurdle for SPY is the 2011 high at $137.18, followed by the 78.6% retracement resistance at $138.26
  • The upper trend line, line f, is currently at $139.40
  • The rising 20-day EMA was almost reached on Monday and is now at $130.18; a close below Monday's low at $130.06 will suggest a drop to the $128.30-$127.20 area; the daily Starc- band is at $129.06
  • The S&P 500 A/D line moved through its downtrend, line h, on December 22, signaling the recent rally
  • The A/D line moved to new all-time highs last week and after a brief pullback has turned up once more; it would take a day of strongly negative breadth to turn it negative on a short-term basis

What It Means: The futures were trading a bit higher early Thursday and a daily close above last week’s highs (SPY: $133.40; S&P 500: 1334) will signal acceleration on the upside.

The action of the iShares Russell 2000 Index Fund (IWM) indicates that buying small- cap industrial or material stock on pullbacks to support should be a good strategy. (See also Fortify Your Portfolio with Steel.)

How to Profit: Buyers who established positions in two small-cap ETFs and one closed-end small-cap fund as recommended here now simply need to adjust the stop levels.

Portfolio Update

Buyers went 50% long the iShares Russell 2000 Index Fund (IWM) at $68.72 and 50% long at $66.88 (average price of $67.80). Half the position was sold at $74.68 on December 28. Raise the stop to $76.68 on the remaining position.

Buyers should be 50% long the iShares S&P SmallCap 600 Growth Index Fund (IJT) at $68.64. Raise the stop further to $76.72 on the open position.

Buyers should be 50% long the Royce Value Trust (RVT) at $11.62. It gapped higher on Wednesday (Feb. 1), closing at $13.72. Raise the stop further to $12.56.

Buyers should be 50% long Volterra Semiconductor Corporation (VLTR) at $21.64. Raise the stop to $25.77 and sell half the position at $32.86 or better.

Buyers should now be 50% long Double Eagle Petroleum (DBLE) at $6.88 and 50% long at $6.56. Yesterday's low was at $6.48, which was the suggested stop level. For those who were not stopped out, it is now at daily Starc- band, so lower the stop to $6.47 and sell at $6.76 or better.

Also, cancel any unfilled orders in the following stocks: WESCO International (WCC), Energy XXI Limited (EXXI), Mentor Graphics (MENT), Pacer International (PACR), and East-West Bancorp, Inc. (EWBC).



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