One of the biggest market leaders is flashing a warning sign

With the Dow struggling to break 20,000 and inauguration day approaching, there are murmurs swirling about the stock market’s near-term performance.

The S&P 600 — comprised of small-cap stocks — is flashing one such warning sign about the market’s next move, according to Andrew Adams, a market strategist at Raymond James.

Small-cap stocks were the biggest winners of the post-election rally. The Russell 2000, a separate index that tracks companies with a market capitalisation of about $1 billion or less, outpaced gains on the benchmark large-cap S&P 500, even as both rose to records.

However, small caps have failed to build on their market-leading gains since the election, creating a reason for caution, Adams said.

“The S&P 600 Small Cap Index has basically gone sideways for over a month now, and even appeared to break down below support on Monday before rallying back over the line yesterday,” he wrote in a note on Wednesday, including the following chart:

“The limited upside and need for caution will remain as long as the index struggles to climb above this zone, and it may take a pullback down closer to 2200 or below to first rebuild enough internal energy to power over this point.”

Adams said it’s noteworthy that mega-cap stocks like Facebook and Netflix are once again market leaders, supporting indexes that are weighted by market cap. At the same time, he observed that fewer stocks are participating in market moves higher.

“Therefore, this remains a time to keep your ears perked up and watching out for trouble… at least in the short-term,” Adams wrote.

“We don’t anticipate a major sell-off like we experienced last January and February, but the scales may be tipping back in favour of caution because it is starting to feel the next 5-10% move could just as easily come on the downside as the upside.”

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