Small cap stocks are extremely weak while Macro is improving. What's next for stocks

*Going forward, the market studies on Tuesday will be for members-only.
The S&P is still sitting at its 2018 lows just before the Fed meeting.

Go here to understand our fundamentals-driven long term outlook.
Let’s determine the stock market’s most probable medium term direction by objectively quantifying technical analysis. For reference, here’s the random probability of the U.S. stock market going up on any given day, week, or month.

*Probability ≠ certainty. Past performance ≠ future performance. But if you don’t use the past as a guide, you are walking blindly into the future.

Small caps’ extreme weakness

The small caps Russell 2000 has been extremely weak during the stock market’s current decline. It’s 14 weekly RSI is now very oversold.

Here’s what happened next to the Russell 2000 when its 14 weekly RSI fell under 30 (first case in 1 month).
*Data from 1988 – present

Here’s what happened next to the S&P 500 when the Russell 2000’s 14 weekly RSI fell under 30 (first case in 1 month).
*Data from 1988 – present

As you can see, the stock market tends to bounce 6 months later, even if it does go lower in the short term. It’s also worth noting that:

  1. During bear markets, this often happened AFTER the stock market fell 40%+ and was close to a long term bottom.
  2. During bull markets, this often happened near the bottom of the “big corrections”.


The Dow’s 3 month rate-of-change is now at -10%, putting the current decline on-par with the February 2018 decline and the February 2016 decline.
Does this mean that the stock market’s bottom is in?

Here’s what happened next to the Dow when its 3 month rate-of-change fell below -10% for the first time in 3 months, while within 20% of a 1 year high.
*Data from 1900 – present

As you can see, the Dow’s forward returns are no different from random on any time scale. This is neither consistently bullish nor bearish for stocks.


Breadth is very weak right now, with less than 26% of the S&P 500 stocks below their 200 dma. Traditional technical analysis sees this as a bullish “oversold” sign.
Is it?

Here’s what happened next to the S&P when the % of stocks above their 20 dma fell below 26% (first case in 1 month)
*Data from 2004 – present

As you can see, the short term is slightly bearish, while 3 months later is slightly bullish.


Gold has been rising during the stock market’s current decline, and will probably soon “breakout” above its 200 dma. Traditional technical analysis states that such breakouts are bullish for gold.
Is this true?

Here’s what happened next to gold when it broke out above its 200 dma for the first time in 6 months (i.e. the first uptrend after a LONG downtrend).
*Data from 1974 – present

As you can see, gold’s breakout can continue for a while (2 weeks), but the returns after that are bearish. Such long downtrends (periods of time in which gold is below its 200 dma) are abnormal. Long gold downtrends typically happen during precious metals bear markets.

XLE and oil

Among the hardest hit sectors during the stock market’s current decline are oil and XLE (energy stocks). The decline in XLE partially explains the Russell 2000’s weakness (a lot of energy stocks are small cap).

XLE is now more than -17% below its 200 dma, and oil is now more than -29% below its 200 dma.
Here’s what happened next to XLE when it fell to more than -17% below its 200 dma (first case in 3 months)

Here’s what happened next to oil when it fell to more than -29% below its 200 dma (first case in 3 months)

As you can see, oil’s 1 year forward returns are mixed. Some bullish, and some bearish. But oil does stabilize 1.5 years later (i.e. a long ways off).


Our Macro Index for January 1 – January 31, 2019 continues to improve. This is still a preliminary reading, so please wait for December 31 when this will be finalized. Whereas Macro fell before the current stock market’s decline, it’s interesting how Macro is now improving.

This would be really interesting: if Macro improves and heals going into 2019. This would give the bull market more room to run.

Some interesting reads

  1. Prepare for more stock buybacks
  2. Stan Druckenmiller: why the short term is increasingly hard to trade, but the medium term is still the same

Click here for yesterday’s market studies


Here is our discretionary market outlook:

  1. For the first time since 2009, the U.S. stock market’s long term risk:reward is no longer bullish. This doesn’t necessarily mean that the bull market is over. We’re merely talking about long term risk:reward.
  2. The medium term direction is still bullish  (i.e. trend for the next 6 months). However, if this is the start of a bear market, bear market rallies typically last 3 months. They are shorter in duration.
  3. The short term is a 50/50 bet

Goldman Sachs’ Bull/Bear Indicator demonstrates that while the bull market’s top isn’t necessarily in, risk:reward does favor long term bears.

Click here for more market studies

7 comments add yours

  1. I really, really like the videos, thank you for doing those.
    I noticed there are instruments that track the VIX. Regarding the 12/19 chart “Here’s what happened next to VIX when the S&P fell more than -1.5%, while VIX was flat/down” – is there a trading strategy or an instrument to “short(?)” to take advantage of the low percentages in that chart?

    • You can try VXX. On the surface, shorting VXX seems terrific because VIX tends to go down + VXX ETF decay.
      But if you do short VXX, do so with a small position size. VIX can spike more (low probability event), which means that VXX can spike. Don’t let a short give you a margin call (which is why I generally don’t like shorts)

  2. Hi Troy,
    Does a big correction close to the end of the bull market always lead to a bear market? Put another way, is there a chance of a medium term rally better than a 50% retracement at this point, or would the 50% retracement be the best we can hope for?

    • Great question Frank. Think about it this way.
      With just the yield curve inversion waiting, the model will turn long term bearish soon, i.e. within the next 3-6 months
      Bear market bounces also typically last 3 months.
      So at this rate, it’s likely the model will turn long term bearish at the same time as the top of the rally.
      If the S&P goes on to make new all-time highs and you’re in cash, focus on long term risk:reward. Past a point, pushing long positions isn’t worth it anymore

      • Although unlikely, if the S&P were to recover from this big correction before the bull market ends, how long would that typically take?

        • If it does, can take anywhere from 2-6 months. That’s how long it typically takes for a big correction to make new highs

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