There's A Rotation Underway Out Of Small-Cap Stocks That Could Be Bad News For Everyone

Small-cap stocks have been lagging the market recently.

Miller Tabak’s Jonathan Krinsky brings this to clients’ attention today, writing, “Generally, when the small-caps show relative weakness vs. the large caps, it is a sign that investors are moving out of the riskier/high-beta names and into the ‘relative safety’ of the large/mega-caps.”

Perhaps the best way to see this rotation out of small-caps and into large-caps is by charting the ratio of the Russell 2000 (a small-cap index) to the Dow Jones Industrial Average (an index of large-caps).

When the ratio goes down, investors are moving into bigger, safer names. That’s what is happening right now.

Krinsky points out that this ratio peaked in February 2012, before the S&P 500 ultimately peaked in early April, as shown by the arrows in the chart below.

DJIA to Russell 2000 versus S&P 500

The chart also shows that the Russell 2000/DJIA ratio has peaked again and appears to be headed lower.

“This is by no means a guarantee of a market top of course,” says Krinsky. “We saw this ratio plunge from July to August 2012, even as the S&P grinded higher.”

This time, it might be saying something prescient, though, given the fact that the market rally hasn’t really faced a major test yet.

“When put in context, however, and combined with many of the other factors we have been highlighting, it should certainly be given some consideration,” says Krinsky.

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