Microcaps Are Exploding
Monday’s stock performance was shocking given the recent run the small caps and micro caps have been on. The Russell 2000 was up 1.25% which means it’s up 11.24% since August 21st. It has been up 7 days in a row and 23 of the last 28 days. The Russell 2000 14 day RSI is at 84.17 which is the highest since October 1987. I think a correction will occur this weak based on this extreme momentum. The other indexes were all green as the S&P 500 was up 0.39%. They all hit record closing highs. The VIX’s 9.45 close is the 5th lowest in history. The KBE bank ETF is now up 12 days in a row which is the longest streak in its 12 year history. The streaks I’ve mentioned thus far pale in comparison to the chart below. The micro caps have gone from flat to up 11.2% on the year. As you can see, they’ve only been down 2 times in the past 30 days. This is a parabolic move that should be sold if you still own a position in the microcaps. Even if you don’t usually trade stocks, a 14.48% return since August 17th isn’t sustainable. Experience shows parabolic moves are usually end in tears.
One of the possible motivations for the rally in small caps could be the tax cuts. I know that the indicator which shows the companies that benefit from tax cuts aren’t rallying, but it’s still a possible catalyst for small caps. This is why looking at the chart below which shows the historical stock market reaction to tax cuts can be helpful. As you can see, the tax cut was passed in October 1986. Stocks got too excited about the plan as they rallied excessively in 1987 before the famous October 1987 crash. Then stocks rebounded as they increased alongside earnings. We are seeing a sharp rally in small caps that might be overly optimistic. The tax plan hasn’t even passed yet, making this rally even more speculative than the one in 1987. The difference is that small cap earnings are increasing unlike in 1986 when S&P 500 earnings were stagnant. I don’t have access to the earnings of microcaps, but the Wilshire Micro-cap ETF had a PE of 15 at the end of Q2. I wouldn’t use that data point as reason to be optimistic about microcaps necessarily. It’s also worth noting how volatile microcaps are compared to the S&P 500. The microcaps rally and crash more often than the large caps.