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If mainstream media pundits are an accurate barometer of U.S. economic health, then we are in the early stages of a broad-based recovery. On top of that assumption, collective trust towards our government, particularly the executive branch, would imply that the best days of American prosperity are still ahead of us. Of course, we have heard this rhetoric repeated incessantly throughout the years, but this time around, a certain ring of authority resonates given the record level valuations of the large-cap equities sector. With investor confidence apparently at an all-time high, who would believe that we are headed towards disaster?

To answer that question, we need to focus in on small-cap equities, or companies with a market capitalization between $300 million to $2 billion (investopedia.com. “Small Cap”.Web.). Unlike the major indices such as the Dow Jones or the S&P 500, the Russell 2000 Small Cap Index did not build beyond its record-setting move in July of this year. While “Big Board” stocks continue to enjoy unprecedented bullishness, most of the companies that comprise the Russell have flat-lined, attempting to recapture its previous momentum but not having the catalyst to do so.

Small-Cap Meltdown Chart 1

This is most evident when we look at its technical chart. When the Russell first breached the 1,200 point barrier back in March of 2014, the spread between the 50 day moving average (the “faster” average indicative of more recent momentum) and the 200 day moving average (the “slower” or lagging average which traces historical momentum) was substantially wider than it was during July’s second go-around at 1,200. Traditional analysis methodologies would tell us that this is a sign of no-confidence by investors; certainly, the Moving Average Convergence-Divergence indicator, or MAC-D, confirms the lack of technical momentum to push valuations higher. On paper, that is, mathematically, what these two indicators are recording is a consideration of both bullish and bearish trading. Rather than focusing on the assumptive conclusions of technical indicators, the more pressing point is that selling pressure, which previously was not evident in the run-up leading to record highs, has entered the market, which led to the “squeezing” of the leading and lagging averages. Indeed, whether a technician employs simple or exponential averages, the broader picture is nearly identical: the bears have finally caught up to the craziness.

Small-Cap Meltdown Chart 2

While this is a technical analysis, the macro-fundamentals should not be ignored. The monthly ADP jobs report indicate that most of the labor market recovery is coming from small and mid-sized companies, or from names that comprise the Russell 2000. Yet if investors are pulling out or selling their positions in these names, what does that say about the future prospects of the small-caps? Diving back into the technicals, the Russell has failed to breach previous highs. It would appear that the bulls are losing their confidence and are sitting on the sidelines, waiting for the next great signal before making their move.

This would likely be a wise move for both the professional trader and individual participants. Bullish energy is losing its impact percentage-wise the higher the index travels, and equity indices by nature tend to be directional. With extremely uncertain fundamentals weighing on markets from both domestic and international sources, and technical pressures not providing much confidence, it would be prudent to take profits off the table and look towards conservative funds to weather a potential storm.

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