EB Daily Market Report - Special IWM Report - Wednesday, March 27, 2024

I've gone out on a limb in 2024, expecting to see renewed absolute AND relative strength in small cap stocks. I believe that the ultimate lowering of the fed funds rate will spark a key small cap group - small cap banks - to begin outperforming. I look for a better lending environment and smaller companies to have a stronger ability to borrow to grow their businesses. As that potential reality comes more into focus later this year, I expect to see significant rotation from large cap areas to small cap areas. This rotation, based on my User-Defined Index (UDI) at StockCharts.com, might already be showing a sneak preview. Here's my INTRADAY relative strength chart between small caps and large caps (IWM:QQQ), updated through Tuesday's close:

Keep in mind that today's intraday action is very bullish, is not reflected in the above chart, and will likely send the IWM:QQQ ratio back above 99.80. I'm keeping a close eye on the 99.82 relative ratio level. We haven't been there since early October, before this significant secular bull market rally began (it started at the close on October 27th).

That bottom panel shows the IWM at 205.17, but keep in mind this chart is as of Tuesday's close. It doesn't reflect today's action, where the IWM is attempting to make a key closing breakout above 208.21:

It's interesting because another small cap ETF, Pacer US Small Cap Cash Cows 100 (CALF), is in a very bullish ascending triangle continuation pattern, and it too is trying to make a key breakout:

From the Fidelity website, here are a few facts about the makeup of the IWM:

Then industry groups......

Banks and biotechs make up more than 16% of the IWM, so these two can heavily influence the direction of the IWM. Today, both are very strong, leading the IWM on the precipice of a key breakout:

KRE (Regional Bank ETF):

XBI (Biotech ETF):

Both of these ETFs are up more than 2%, heavily influencing today's strength in the small cap IWM.

The CALF is a much different small cap ETF. First, this ETF concentrates on the "best of the best" mentality. Most small cap stocks are unprofitable. CALF, as its name would imply, looks for the cash cows, those small cap companies generating profits and free cash flows. Check out where the money is invested within the CALF:

Zero financials representation is the first thing I see. This helps to explain why the CALF has outperformed the IWM over the past few years. The lack of banking exposure has been very beneficial.

How about industry group representation?

Specialty retail is a big difference maker between the IWM and the CALF as representation totals 2.79% and 11.29% in each, respectively. This group has been a huge tailwind for CALF, as you can see below:

I own both the IWM and the CALF as they each approach small caps in different ways. Fundamentally, I'm a fan of CALF as it ignores many of the small cap areas that struggle to make money. However, CALF has no bank representation, so if I'm right about banks showing leadership later in 2024, exposure to the IWM makes sense.

It's now a tad before 3pm ET and the IWM is currently trading at 208.49 - this is breakout territory. It needs to hold on for the final hour, but right now things are looking up for this asset class. A confirmed close above 208.21 today (the further above it, the better), increases the likelihood of a further short-term advance in small cap stocks.

Keeping it real!

Happy trading,

Tom