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Short Term Internals Still Point To Higher Prices, But There Are Some Longer Term Red Flags Appearing

Aug. 18, 2014 7:36 PM ETIWM, VTWO, IJR, SPY
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So it looks like we are again in rally mode, with the major indices up again today. The small cap Russell 2000 Index pushed above its 200-day moving average and gained an impressive 1.47% by day's end. The large cap indexes performed well too.

So what next? Will the Russell 2000 again try to rally, but fail again at its early March high? See the picture below. The resistance point is right around 1210 on the index.

Meanwhile, will the large cap indexes continue to make new highs? At this point, it appears both scenarios are likely. First, to be clear, all of my proprietary measurements of the internal health of the market point to further gains in the days ahead (short term). These gains will likely be broad based, with momentum stocks and high beta names gaining the most.

It still seems, however, appropriate for small companies to continue to underperform over the intermediate term, given the length of the bull market and the higher valuation of various small cap indexes (versus large cap indexes). There are a few technical patterns which seem to be supporting my speculation.

First, two weekly charts with their respective RSIs. Notice the negative divergence in the Russell 2000 RSI, but not the S & P 500. That's a testament to large cap strength, and perhaps a leading warning for continued small cap weakness.

The S & P 500

Then the Russell 2000

The Russell 2000, which is comprised of small and typically more "sensitive" stocks is showing signs of internal weakness. This is confirmed by continued weakness in the NASDAQ Advance-Decline Line.

So, what does this all mean? In short, bought the dip, enjoying the rip, but keep an eye on your small and micro cap stocks, since signs of weakness are starting to appear. By all means, don't go shorting anything, but just don't be surprised if the small cap underperformance continues into the weeks, or even months ahead.

~D

Analyst's Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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