Chart of the Day – $IWM / $SPY: Continued Divergence

by Enis August 21, 2014 11:18 am • Commentary

Today is the second straight day that the Russell 2000 is underperforming the S&P 500 by more than 0.5%. The weakness in the Russell has been a feature of the market ever since many high beta stocks topped out in March, but the most recent bounce has been the most tepid by far for the widely followed small cap index.

Here is a comparison of the return of the Russell 2000 vs. the S&P 500 index so far in 2014:

S&P 500 index in green vs. Russell 2000 index in red, Percentage return year-to-date, Courtesy of Bloomberg
S&P 500 index in green vs. Russell 2000 index in red, return year-to-date, Courtesy of Bloomberg

On both the Feb-Mar rally and the May-July rallies, the Russell 2000 made a catch-up  move towards the S&P 500 index.  That has been absent so far in the current rally, particularly with the weakness in the Russell over the past two days.  Moreover, the small cap index is now negative on the year, after briefly touching green earlier this week.

The IWM/SPY ratio is back near 2 year lows as a result of the weakness in IWM so far this week:

5 year daily chart of IWM/SPY, Courtesy of Bloomberg
5 year daily chart of IWM/SPY, Courtesy of Bloomberg

The relative weakness in small caps does not necessarily imply imminent market weakness, as the S&P 500 index has continued higher since March without the small caps in tow.  However, it does illustrate the lack of demand for the smaller issues in the market, suggesting that investors are becoming more discerning over the past 6 months as valuations get more elevated.