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Large-Caps Stocks
The Smart Profits Report: Issue #346
Monday, August 21, 2006
Large-Caps Stocks: How Point Spread Shows Large-Caps Re-establishing Dominance
By Jim Stanton
Advisory Panelist, Mt. Vernon Research
Since the bear market ended around October 2002, the small-cap indexes have been the place to be. In May this year, for example, the Russell 2000, S&P 400 (mid-cap index) and S&P 600 (small-cap index) all set record highs. At the same time, the “big boys” failed to follow suit.
But times are changing. Since then, the smaller-cap indexes have lost their luster and the major players are now back in the ballgame. It’s time to get back into large-cap stocks again.
Trust the Technicals: Trend Finally Shows a Large-Cap Stock Resurgence
The chart below shows the point differential (spread) between the S&P 500 and the Russell 2000. As the S&P declined and Russell 2000 advanced, the point spread has gradually dwindled since December 2005. This shows that the Russell 2000 was outperforming its larger counterpart.
That was until April this year, though, when the spread began to stabilize. Then, as the indexes made their push toward the May highs, the S&P 500 took the lead role. Since putting in a low, the spread between the S&P and Russell 2000 broke above its downtrend line in May and has raced upward ever since, making new highs for the year.
Chart Courtesy of Trade Navigator Software
The battle between large-cap stocks and small-caps is a frequent and compelling topic of discussion among economists and commentators, both in print and on television. But despite having said the strength in the small-cap indexes vs. the large-cap indexes was coming to an end and that the large-caps were poised for an imminent resurgence, this is the first valid evidence that I’ve seen to make that call.
That’s the beauty of technical analysis. It brings to mind the old saying, “A picture is worth 1,000 words.” But there are also some good fundamental reasons why the large-caps are the place to be going forward…
Time to “Go Large” Again?
There are three major underlying reasons for the shift to large-cap stocks:
- The Fed has stopped raising interest rates, despite the continuing threat of inflation. This tells me that they also see a slowdown coming and that their main concern now is to avoid a recession.
- With the change in the housing market over the last six to 12 months, it has to affect consumer spending. With house prices in some areas having doubled over the past five years, it gave homeowners a greater sense of financial security and encouraged them to spend more. But today, the correction has taken hold and some house prices are not just cooling off, they’re falling. That results in consumers tightening their purse strings.
- In response to economists arguing that economic growth will slow over the second half of the year, investors are becoming more defensive and conservative. That means they’re shifting toward the bigger, safer companies that can afford to pay a decent dividend, which exceeds the rate on most money market accounts.
This macroeconomic evidence, coupled with the technical analysis showing a fast acceleration in the spread between the S&P 500 and Russell 2000 seems to confirm that the large-cap stocks are now back in favor.
Protect Yourself By Adding Large-Cap Stocks To Your Portfolio
In addition, the September-October period is generally a weak one for the markets - especially at mid-term election time. So to protect yourself, you should take advantage of this trend and look to add some large cap stocks to your portfolio.
In every mid-term election year since 1990, the markets have established a significant low point during the election cycle. So pay close attention. If history repeats itself, you might get a chance to pick up some good, solid stocks at lower prices in the next month or so.
Good Trading,
Jim Stanton
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Today’s Smart Profits Cribsheet
- Spotting a shift in trend from bearish action to bullish is key to getting in early and then riding the wave upwards. But you don’t have to fork out all your capital buying individual stocks. There’s an easier and cheaper way, simply by buying index options. Find out how to do it in Smart Profits #215: Index Options: A Billionaire’s Trading Tool Anyone Can Use.
- But how exactly do you spot key technical changes in trend? We’ve got two simple tools that will enable you to do so in Smart Profits #214: Technical Analysis: Two Simple Tools for Spotting a Technical Trend.
Related Articles:
- Trading Index Options: Two Ways To Profit
- E-Minis & ETFs: “Trade” E-Minis With Less Risk Using ETFs
- Double Your Money: The Truth About Making 300% Overnight in Options
