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Coming off of another record high on Wednesday the Dow Jones Industrial Average looked on while the Nasdaq and S&P 500 fell. That was led by those stocks listed on the small market capitalization net Russell 2000. It’s not the end of road for the small capitalization stocks yet however. Financial research specialists at Leuthold Group, which is led by Doug Ramsey, James Paulsen, and Scott Opsal. This team says that there is a “long-term leadership cycle” in the small capitalization stocks that is under way, and it could be bad news for the large indexes.


The Russell 2000 index continues to register as ridiculously overbought based on readings from multiple technical factors, says the team of researchers, and that may be the reason for caution on the market in the short term. But there is an inherent and extreme strength of the index that supports all three of Leuthold Group teams’ view that the dominance of these stocks could be here to stay. Since January, the small capitalization performance pushed the six month total return spread between the Russell 2000 and the S&P 500 to over 25% for only the eighth time since 1960. For the kicker there is consistency, in all of the previous seven cases it was in the beginning or midway through a cycle that small capitalization stocks led traditional stocks relative to the Russell 2000 breaching 25%.


This could mean that more is likely to come of it, although it isn’t necessarily a healthy sign for the overall stock market. Going back to 1960 the annualized returns for the S&P 500 were almost 6% lower when smm capitalization stocks have taken the lead. According to the researchers at Leuthold Group, they say that a portfolio that is half cash and half small capitalization stocks could match the S&P 500 for volatility in the next couple of years while returning at a higher level.


The backdrop of this is also rising United State treasury yields that is not very likely to get in the way of the groups trajectory, according to them. Small capitalization stocks are actually showing what they consider a decisive performance edge during the recent periods of aligned movement between stock prices and bond yields. Be sure to check how the job market is moving and the movement of new Initial public offerings on the indexes over the next few years to track this movement and results.


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