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Large Caps Waiting for Small caps and Retail

David Becker
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Although many parts of the US equity markets have broken out to new all-time highs there are still many sectors that refuse to follow which is placing a drag on the broader markets. The S&P 500 and Dow Industrials notched new highs yet again on Monday, but the Russell 2000 remains well below its spring highs and continues to lag. It is quite rare to see a negative correlation between the S&P 500 and Russell 2000. This means that the two indexes are not moving in tandem.

In addition, to the Russell 2000, the Retail SPDR (XRT), the Regional Bank SPDR (KRE) and the Home Construction iShares (ITB) are also well below their spring highs and lagging the broader market. These three groups are important to the broader market and may ultimately resolve the discrepancy between small-caps and large-caps. Retailers are important because retail spending accounts for some two thirds of GDP. Regional banks are important because they feature prominently in the small-cap finance sector, which is the biggest sector in the Russell 2000. Housing is an important component to the economy.

The S&P 500 is up approximately 4% year-to-date, but XRT, ITB and KRE are down year-to-date and showing relative weakness. These three could hold the key to stock market performance in the coming weeks. Breakouts in all three would be very bullish and help small-caps. Continued relative weakness and breakdowns would likely drag down large-caps.

The Retail SPDR is bouncing off the 80-81 area three times since mid-April. These bounces prevented a break down, but the ETF remains range bound since mid-April and well below the spring highs. A break below the support zone (80) would be quite bearish for retail and this would likely pull down large-caps. Look for a surge above the May highs to signal a revival in retail that could lead to relative strength in small-caps as the market embraces more risk.

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