Best Canadian Small-Cap ETF Compared to US Small-Cap ETF

April 12, 2024No Comments


The Russell 2000 Index – Looking at Canadian Small-Cap and US Small-Cap Stocks


They say that good things come in small packages, so today we’re going to talk about small-cap stocks. And we’re going to look at both US [00:00:30] small-cap stocks and Canadian small-caps. So, I wanted to start this presentation by looking at the Russell 2000 [00:01:00] because that’s the classic small-cap index. Now it covers the US Small-Caps, and as the name suggests, it covers about 2,000 stocks – well, 1,955 to be exact. [00:01:13] So, it’s not quite 2000, but close enough.   

I want to talk about the differences in the charts, so, what I’m going to show you here is the Russell 2000 chart. Notice it was in a long base, it fell quite a bit in 2022 (like everything did), and then it moved into a very, very long base from the beginning of ’22 until this year. It stayed in that base and [00:02:00] recently broke out in the past three months or so. It’s been quite a move, and we always like base breakouts. So, this is a bullish chart from a purely technical point of view.

Shares Russell 2000 ETF

There are a couple of things I want to talk about, and then we’ll compare this to the Canadian small-caps. The first thing I want to discuss is seasonality. And there is no seasonality that I’m aware of for the Canadian small-caps. At least I haven’t [00:02:30] found anything, but maybe some of the seasonal guys have been exploring this area on the Canadian stocks. But on the US side, because it’s a well-traded market, the small-caps in the iShares Russell 2000 ETF (IWM is the ticker) – are very, very well-traded. It’s highly liquid. [00:02:58]


Brooke Thackray’s Views on Small-Caps

I want to read from Brooke Thackray’s 2023 book – not his new ’24 book – but they’re going to be fairly similar. The small-caps outperform the market from about mid-December to about mid-March. As you can see, I’ve outlined, that right here if you can see it in yellow. [00:03:15] So, if the market tends to favour small-caps between mid-December and mid-March, that would kind of make sense, wouldn’t it? Because here’s December of ’23 and you can see [00:03:30] this vertical line here, is the beginning of ’24. From December to now, the market’s been pretty kind to the small-caps. So, it makes sense that we’re now coming to the end of the season for small-caps. And you can see if we go down to some of the momentum indicators, they’re rolling over. [00:03:52]


What the Indicators are Saying

This is money flow momentum [00:03:54], which looks at the amount of money flowing into a stock, ETF or sector. [00:04:00] Because IWM is so widely traded, it’s a really good benchmark for the small-caps in the US. And, you can see that they’re falling out of favour again, money is flowing out of them. That’s indicated here because the momentum is slowing on money flow, and you can see the volumes declining. So, you had that rising trend, but volume has declined steadily through that rising trend, meaning it probably wouldn’t last for long. And you can see that on the money flow momentum. [00:04:30] Now MACD, when you look at the two lines, they’re trending up, but also take a look at the histogram. It tells you ahead of time what might happen with the MACD. You can see the histogram has been moving down and the bands are squeezing. [00:04:46]

So, that probably tells us that again, price momentum in this case is slowing down. Now MACD uses two different moving averages and compares the differences, but it is really still just a measurement of a price trend. [00:05:00] Last but not least is RSI, which is one of the classic price momentum indicators and it’s gone totally flat. So this move, you could say it’s diverging negatively against the move because the move has been positive on the Russell 2000, (the IWM ETF), but it has not been positive for any of these momentum indicators over that period. So that’s a warning sign. 

And maybe per Brooke Thackray’s observations about the small-caps after March, [00:05:30] we’re going to see this sector pull back to the neckline. At some point though, based on standard technical analysis, you’d think that if the sector or the ETF touched the neckline, which lies somewhere around the moving average, around $195 or so, if that were to be tested successfully, then you could probably expect another rally in the future. But for the time being, it’s telling us that maybe it’s a little long in the tooth this [00:06:00] rally. Now, on the other side though, there is plenty of upside if it does retest and then move back to its old highs of late ’22. So keep that in mind. But I think with seasonality and the indicators we’re seeing on the chart, it’s not necessarily the best play right now despite that breakout. 


Canadian Small-Cap ETFs and Their Indicators

So, now let’s take a look at the Canadian ETFs, and that includes the iShares one as well. [00:06:30] XCS is the ticker on the TSE, and it’s the Canadian small-cap ETF. It has a very similar pattern except for a couple of things. First of all, after that sideways pattern that occurred over the same period from ’22 on, you saw a breakout, but that breakout is really moving along and not too far off of its old highs. [00:07:00] The other thing I want you to notice is that momentum is not rolling over. Remember the money flow indicator we looked at for the Russell 2000? Well, it was already rounding down against an uprising market, but the money flow momentum indicator here is still moving up. In MACD, here’s the histogram. You’ll recall the histogram can give us a little bit of a clue as to what the MACD itself might be doing. Well, you can see the [00:07:30] bands are actually separating, which is good, and the histogram is moving up. So again, there is muscle behind the Canadian names. And last but not least, RSI, which has definitely moved up – yes, it’s a bit overbought – but stocks can sometimes stay overbought for a while just like they did way back in 2020/21. So, all seems like a better picture for the Canadian small-caps. [00:07:56]

ishares S&P TSX small cap index ETF TSE

Sector Breakdown for the US vs Canadian Small-Cap Stocks

Now this might be because of the sector breakdown. [00:08:00] We talked about the Russell 2000, being made up of 1,955 stocks. It’s 62% represented between Industrials, Financials, Healthcare and Internet Technology. But of those four sectors, they’re all [00:08:30] pretty evenly spaced out. If you look at Industrials, there’s 17% of that index, Financials – 15%, Healthcare – 15%, and Internet Technology – 15%. So, even though there is a concentration in four sectors in the market, there’s not one particular sector that’s overweight. 

Now let’s contrast and compare that to the iShares Canadian ETF (XCS ETF). It’s 30% Materials, another [00:09:00] 22% in Energy, and 12% or so in the Industrials, for 64%. So pretty close. Both of these ETFs have around 64% spread over a few sectors, but in this case, it’s three sectors versus four on the Russell. And two of those three sectors (Energy and Materials) have over 50% of the market [00:09:30] invested.

Now, that does explain when we go back to that chart for the XCS, why it’s moved so strongly and why the momentum indicators are not rolling over yet. Because Materials are on fire right now. And if you’ve been following my work, you know I’ve been talking about materials and energy for several months now. So, don’t say I didn’t tell you ahead of time. It is no surprise to me that the Canadian small-cap sector looks better [00:10:00] than the US small-cap sector.

I don’t know about the seasonals, but given that 60% of the index is concentrated in Materials and Energy, and to some point Industrials, these sectors are all actually in favour, including industrials, right out until the spring. So, if I were to bet my money on the small-cap sectors, I’d probably be looking in the Canadian side [00:10:30] for now, and then switch over to the Russell 2000 if/as/when Materials and Energy get past their seasonal period of performance. 

So, I hope that helps. Kind of short and sweet, just one topic, but I think it might give you some ideas of where to look for your next investment candidates. Thanks for watching. We’ll be back next week.

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