Small capped stocks are consolidating

In about a month, small capped stocks are supposed to move into their seasonally better time of the year. This, according to all of the seasonal gurus out there. The problem with classifying a small capped stock index is that capitalization, by itself, does not necessarily lead into correlation. In English, what I am saying is that if you take a bunch of stocks with say, only half a billion in capitalization – they could be in a multitude of different, non-correlated  industries.

For example, the TSX small capped index ETF run by iShares (XCS-T) has heavy weightings in materials & energy, followed by more moderate weightings (yet still significant) in industrials, real estate, financials. etc. By themselves, none of these sectors are correlated – the only commonality being their capitalization.

The Russell 2000 small capped index, represented by the iShares ETF (IWM-US) holds a different mix than its Canadian counterpart. Its a bit more evenly distributed, and much less focused on energy and materials. It’ s pretty well distributed between industrials, technology, healthcare, financials, cyclical and real estate – with far less energy and materials in the mix. To a greater extent, the only commonality of the stocks in the index is the capitalization.

My question is: should we classify these stocks as an index just because they are of a certain capitalization? Do they correlate well enough as a group to draw conclusions as to how the crowd might view and trade them? Perhaps the crowd moves out of small caps on the whole due to risk aversion. That’s the theory. So, working with that somewhat fuzzy logic, lets look at these two ETFs from a technical perspective.

Canadian small caps

The XCS ETF likes to move sideways. After being trapped below a $16 lid between 2017 to the end of 2018, the ETF broke down. Then, it picked back up again this year, only to be trapped in a very narrow range from $14-$15. Clearly, this is a traders vehicle – without much movement to offer you an attractive risk/reward profile. The range is about 7%, but the volume on the ETF might make your trades less efficient due to the low liquidity. The pattern tells us that materials and energy stocks (the biggest holdings) are lost in space for our markets. There’s no edge here to suggest an opportunity on the ETF unless you wish to try for the dollar upside on a bounce from $14. Personally, I wouldn’t bother, given the low liquidity and low profit potential.

US small caps

You might have gathered from my comments above that I prefer the distribution and diversification of the IWM ETF over the Canadian counterpart. This security has been trapped in a sideways range like XCS – but its probably a more tradable vehicle for those inclined to move in and out. It does have vastly more liquidity than XCS (volume), although it only offers a similar range for swing trading. That is, support lies around $143, resistance comes in at just under $160 – that’s about 8% if you time it right.

I do note that the inflow (new money into IWM vs. out) is at levels that, according the data from sentimentrader  tends to lead into rallies on the ETF. This coincides with the ETF playing within its lower trading zone of support.

Conclusion

Put a gun to my head and I’d go with IWM if I wanted to try to play the small caps. It doesnt turn my crank enough to inspire such a trade, but that’s the better choice if I had to make one. You might have a trading strategy that can accept lower profit potentials. At least on both of these charts we can easily spot the support line, thus inherently create a stop-loss decision if the trade goes wrong. Food for thought. Happy trading!