Small Caps Shine

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Small Caps Shine

Market Moves

Stocks were mixed and flat on Monday as tech stocks, led by Microsoft Corporation (MSFT) and Alphabet Inc. (GOOGL), weighed on the tech-heavy Nasdaq Composite for much of the trading day. The Dow eked out a small gain, while the S&P 500 was nearly unchanged. Both major benchmark indexes are only a stone’s throw away (around 2%) from their respective all-time highs – the latest market rally having been driven by a perception of easing U.S.-China trade tensions.

What was most notable about Monday’s market price action, however, was the movement of small-cap stocks. After a prolonged period of severely lagging its large-cap counterparts, the small-cap Russell 2000 index has finally begun to show signs of life. The Russell 2000 beat the S&P 500 by a significant margin both late last week and then again on Monday, when it shot up by well more than 1% while the Dow and S&P 500 ended relatively flat.

Why does this matter? Small-cap stocks are considered by many to be both a gauge of investors’ risk appetite as well as a leading indicator of the broader stock market. Therefore, when we see the Russell 2000 surge, especially when large caps lag, it’s often seen as a sign that investors are willing to take more risk. And if this is indeed the case, the large caps could soon follow higher.

As shown on the chart of the Russell 2000, the index has made a sharp rebound off the August support level. Currently, price has reached back up to the key 200-day moving average. This could serve as a resistance barrier to further gains, but if the index is able to break above the average, we could be seeing a strong recovery for small caps.

Yields Bottoming?

We’ve discussed falling bond yields at length in recent months. The benchmark 10-year Treasury yield has fallen more than 55% at its worst within the past year. But since late last week, yields have been showing signs of a potential bottoming. Due in part to easing U.S.-China trade tensions, the 10-year yield has rebounded strongly – up around 14% from last week’s lows to Monday’s close. While it’s difficult to say if this yield recovery will last, any more positive developments on the trade front should lead to more economic optimism and further gains in bond yields.

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Semiconductor Stocks Near Record Highs

Another sign that concerns about the trade war are likely dissipating can be seen in the prices of semiconductor stocks. Semiconductor companies are particularly susceptible to U.S-China trade conflicts. As shown on the chart of the VanEck Vectors Semiconductor ETF (SMH), chipmakers as a group are up over 6% since trade concerns eased last week. Currently trading around the $120.00 handle, SMH is not far off its July all-time highs. Any further good news on the U.S-China trade front is apt to push semiconductors into record territory.

The Bottom Line

The current stock rally began in earnest last week, and we’re now seeing more signs that investor sentiment is improving markedly. From Monday’s small-cap surge to the continued rally in semiconductor stocks to the sharp rebound in bond yields, markets appear poised to reach toward record highs once again.

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