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Small-Caps Sizzling, But The Rapid Advance Won't Hold

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At the beginning of January, I said "small-cap stocks will be a key driver of the broader market should the U.S. and global economy continue to improve" in 2013.

Small-cap stocks have been impressive early on in 2013, as the Russell 2000 is up 8.7% this year, increasing 2.3% in February alone, with the index trading at record highs above the 900 level. Small-cap stocks are easily outperforming the broader market in 2013.

In my view, continued economic renewal will drive small-cap stocks higher, as these companies tend to be able to react quicker to a changing economy.

The strong start to 2013 is also a bullish sign, as was the case in 2012, when stocks flew out of the gate. We are seeing a similar situation this year, so expect some gains.

But what I'm concerned about is the rate of the advance; in my view, unless you believe the Russell 2000 will gain 65% this year based on an annualized rate, the index's rate of advance is clearly not sustainable. And you know this is highly unlikely, so you should expect to see ebbs and flows going forward. The last big year for the Russell 2000 was a 25.3% gain in 2010.

The chart of the Russell 2000 below shows the break at the horizontal resistance line that had been in place since 2011. While the relative strength and moving average convergence/divergence (MACD) indicators are both flashing "buy" signals, the angle of the recent breakout, marked by the blue oval, clearly indicates an unsustainable advance, so be careful.

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