When The Soldiers Fall, How Soon Before The Generals Surrender?

One of the more interesting stories from last week is the extent of outflows (redemptions) currently being experienced at key exchange-traded funds (aka ETF's) like the Russell 2000 iShares (symbol IWM). This is the largest of the small-cap ETF's with $23.6 billion under management where outflows totaled $2.2 billion, or 8.6%, last week. The smaller leveraged cousin ProShares Ultra Russell 2000 actually lost an incredible 41.4% of its assets under management last week. While outflows in the largest ETF of them all, the SPDR S&P 500, weren't nearly as significant on a percentage basis (-1.77%), the total redemption (outflow) in the SPY ETF was still noteworthy at $2.8 billion last week. 

The Russell 2000 Index closed below its 200-day moving average line last week, and most technical analysts are all asking the same question. Will the small-cap stocks rebound or will large-cap stocks soon turn down to match the losses sustained recently in small-cap stocks? My best guess is reflected in my current position which is effectively a leveraged bearish short in the S&P 500 Index (using the SDS ETF). 

The Russell 2000 Index peaked on March 4th, 2014 at 1,212.80. It then fell almost exactly 10% to an intra-day low at 1,091.50 this past Friday, May 9th before bouncing about 1%. If the 5-year bull market in U.S. stocks is still alive, then small-cap and battered momentum stocks will rebound sharply in the days and weeks ahead, and the larger stocks will probably tread water or trend slightly higher. If a major correction is now underway, as I believe is the case, then the large-cap "generals" will soon fall sharply to join the small-cap "soldiers" in full retreat.

Russell 2000 Index Daily Chart with 200-Day Moving Average Line

Russell 2000 Index Weekly Chart with 20-Week & 40-Week Moving Average Lines

P.S. In my February 16th, 2014 column I wrote the following: "Gold/Silver mining stocks are probably "fairly valued" now and should therefore be scaled back or completely liquidated in most portfolios." Gold/Silver mining shares had rallied between 30% and 100% from their December 2013 lows to their February peaks, and my recommendation in mid-February was to take profits and wait for the next great opportunity in this volatile sector. While my computer system has yet to trigger any meaningful "buy" signals here, on Friday, May 9th I purchased several Gold/Silver mining shares for the first time since February. My allocation to this sector went from 0% to 14% this past Friday. While 14% may seem high, my allocation to this sector peaked at 40% in late December 2013. Right now, I like Silver more than Gold, but if one rallies then both will probably rally. And if/when the Silver ETF (symbol SLV) advances above it long-term downtrend line at $20/share, then upside potential for silver mining shares looks explosive. In the interest of full disclosure, I am now long First Majestic Silver (AG), Endeavour Silver (EXK), and Primero Mining Corp (PPP) in my largest managed account.