Questions often arise about the price and internals behavioral differences of the small cap index proxies RUT and SML. As discussed before on TW, the threshold of membership for SML is far more rigorous than the much broader based RUT.
With bull market now over 30 months old (assuming the bull is still alive) a look at what the maturing bull's impact has been on the "blue chip" SML small caps versus the broader based RUT internals, might be warranted for those interested.
First, a look at the SML AD MCO over the past couple of years (bull phase). For the SML components, MCO postings in the +70 and above zone are usually initiation thrusts for the short term, and the intermediate term unless immediately preceded by an extreme low as illustrated by the SML AD MCO postings below -100. In the case of an extreme MCO low followed by a MCO initiation thrust level, a nice price pop occurs over the next six to eight weeks. Then SML proceed to put in a nominal lower price low than the extreme MCO lows accompanying price low.
Between August and October of this year, the SML put in a triple bottom in the more moderately oversold zone of -70 to -75. Following the third leg of the bottom, a robust upmove to +67 followed. The +67 level is not an initiation thrust extreme, but has typically been sufficient in this bull market to spark prices higher for awhile.
Expanding the SML AD MCO chart back to the July 2002 lows, one can see the SML's extremes were higher and lower while the bear market was in the process of bottoming. Note the extreme MCO initiation thrust in August 2002 coinciding with the SML price high post prior to the dive into the October 2002 price lows.
Here is the RUT AD MCO behavior over the past couple of years. By comparing the AD MCO extremes of SML with RUT over the past couple of years, note the broader based RUT extremes are not as large in magnitude as the SML's. Also notice, the rally after the May 2004 and January 2005 lows resulted in new recovery price highs for the SML, while RUT did not make new price highs. Particularly from the January 2005 low, the RUT AD MCO could not even break the +50 level, providing a warning the correction process had more work to do.
Note the RUT AD MCO volatility did not match the extreme lows of the narrower based SML AD MCO near the end of the bear market in the second half of 2002.
Next is the SML cumulative AD line. As shown in the RUT AD line chart displayed later, the component quality differences surface. Note the cumulative SML AD line confirmed the price highs in early August 2005 and has recently broken its resistance trendline.
In contrast, the RUT cumulative AD line fell significantly short in confirming its early August 2005 price high and currently has a ways to go before challenging its resistance trendline. The evolving disparity between breath strength in SML and RUT confirms available liquidity for stocks has become more selective this year.
Note the RUT cumulative AD line is now directly beneath the apex created by its resistance trendline and the support line from its April 2005 lows. For any further upside action, the current trendline apex level will be an important test for the RUT AD line.
The SML up-down volume (UD) MCO has also reached the positive zone where initiation thrusts are often posted.
The RUT UD MCO is currently consolidating around the +50 zone, certainly not at levels typically associated with initiation thrusts. This is not a positive sign unless it can start mustering more strength soon.
The SML cumulative UD volume line has sliced through its 5% and 10% trends, but has it resistance trendline to contend with next. Thus far, volume is lagging breadth with the SML components, so now the bulls need to start pumping more volume into this group. The cumulative UD line is raw, not ratio adjusted, so is not measuring up volume to down volume ratios.
The RUT cumulative UD volume line, like its AD line cousin, did not confirm the higher RUT price highs in early August. This behavior is additional evidence of more selective money flows into small cap issues.
A look at the SML AD McSum. Assuming it doesn't break its October low in the near term, it is encouraging the McSum not only posted a higher low than the May 2005 low, it also bottomed at a higher level than its May 2004 and August 2004 lows. Barring ant complete collapse Monday, the SML AD McSum will take out the early October hook resistance.
The RUT AD McSum, like its higher class SML cousin, has also managed to remain above its three prior important lows, but unlike the SML AD McSum, the RUT version needs another +120 points to exceed the early October hook high.
The SML UD volume McSum found nice support at trendline across its August 2004 and April 2005 lows. But the SML volume McSum is not as well postured as its AD McSum brethren with respect to taking out its early October hook high.
The RUT UD volume McSum has surprisingly fared better than the SML UD volume McSum with respect to the magnitudes of their respective lows. Both the RUT and SML McSum variants are ratio adjusted. By revisiting the RUT and SML UD volume MCO graphs, one can determine why the disparity in the UD McSum lows occurred. The SML UD MCO spent more time in the -50 and below zone than did the RUT UD volume MCO.
The SML $ weighted up-down volume MCO just reached the thrust initiation levels it achieved at the April 2005 lows, after exhibiting a nice positive divergence from the mid and late October price lows. The recent action with this indicator in encouraging in that it measures the dollar weighted UD volume signaling solid money flow into the SML components over the past two weeks.
The RUT $ weighted UD volume MCO has thus far fallen a bit short of solid thrust initiation levels suggesting again, money is flowing more selectively into small cap issues.
The SML cumulative $ weighted UD volume line is again assaulting its previously tested resistance at 30,000. Note the declining price tops since August, while the cumulative $ weighted UD line was stronger than the SML price.
The RUT cumulative $ weighted UD volume line is challenging it September and early October highs, similar to SML. The nature of the $weighted UD volume indicator can explain this behavior. It implies more money is flowing into the higher priced components of the small cap indices than the lower priced issues, thus more evidence of more selective behavior by investors with small cap issues.
From the small cap sentiment front, next is the NAV adjusted money flows in the Rydex leveraged Mekros fund. Doesn't appear to much interest from the Rydex hot money in this speculative leveraged fund.
The non-leverage Rydex small cap growth fund money flows aren't there either.
The Rydex small cap value fund isn't getting any respect from Rydex investors. The Rydex small cap long fund investors are apparently still smarting from the price decline since the August top. An excellent wall of worry measure.
The Rydex small cap inverse (short) fund investors appear to hesitant to cover their short positions. Although the NAV adjusted inverse fund assets have declined since the price bottom, the indicator is still at levels one would not expect considering the inverse fund players have been taking it in the "shorts"
In summary, signs of waning liquidity are becoming more evident over the past 10 to 12 months, particularly in the lesser quality small cap issues. Unless excess liquidity begins rolling indiscriminately into all stocks going forward, the bull market from early 2003 may have seen its best days with respect to breadth. The small cap breadth numbers, particularly the broader based RUT, usually serves as the canary in the liquidity coal mine, and the canary is obviously sick.
Unless the liquidity trend abruptly changes, small cap investors may want to consider value orientated stocks/funds, and due diligence when trading the long side of small cap growth stocks. From the money flow indicators discussed, there are obviously some small cap growth and value issues attracting impressive money flows, but the days of throwing darts at list of small caps for investment selections are apparently behind us.
The good news in the near term for small caps, is they are still out of favor as measured by the Rydex money flows, in spite of a nice price rally in the small cap indices. The hesitancy of traders to jump on the more speculative small cap funds implies there is more room for price appreciation in the intermediate term