Do Small Cap Stocks Lead the S&P?

A couple of readers suggested that I take a look at what happens with the S&P market as a function of strength in the small cap (Russell) stocks, given the recent outperformance of those small caps. I recently sent off an article to the Trading Markets site that should appear Friday AM that will present one facet of this issue. In this analysis, I focus on markets since January, 2003 (N = 768) in which the Russell is up on a one, two, and three day basis, with the three-day gain exceeding 2% (N = 130).

Three days later, the S&P is up by an average of .45% (87 up, 43 down), much stronger than the three-day average gain of .07% for the remainder of the sample (358 up, 280 down). A strong Russell, such as we've had lately, has led to near-term large cap stock strength. In this context, it does appear that small stocks do lead large ones during strong moves. This may be because small stocks tend to be more volatile and thus will outperform during bullish trending markets.