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The Nasdaq Composite (NASD) is down over 8% year-to-date (through 1/19), which marks its third-worst start to a calendar year with data going back to 1977. The last time we saw a worse start to the year was in 2016 when the index was already off over 10% at this point. The Nasdaq 100 (NDX) is also under pressure, marking its third-worst start to a year since 2016 with a loss of 7.8%.

It is rare to see these indices treading underwater at this point in the year; in fact, over the past 45 years (including 2022) the Nasdaq Composite has only experienced this 13 times or said differently, the index has been positive by January 19th 70% of the time (there is nothing special about January 19th other than it is the most recent day of market action used in our lookback period). Apart from a couple of notable outliers, we see markets finish the year in the positive territory about 2/3rds of the time. However, we also tend to see elevated volatility persist – evidenced by the fact most drawdowns intensified.

Although many Nasdaq Composite/NDX-related areas of the market are trading near washed-out territory, based on this small data set we could reasonably expect to see further buying opportunities. The current environment could be likened to the metaphor of catching a falling knife, which we try to avoid. So, remain patient, keep a close watch on bullish percent charts in oversold field position, and wait for demand to reenter the picture with Point & Figure buy signals on individual trend charts.

In yesterday’s (1/19) trading, the iShares Russell 2000 ETF (IWM) broke a spread quintuple bottom when it hit $205, taking out support that had held since March of last year. The fund now sits at roughly the same level it did in early January 2021, about 15% off the all-time high it reached in November of last year.

With the violation of major support yesterday and IWM now trading in correction territory, today we wanted to take a deeper look to see which areas of small caps have held up the best and which have been particularly weak.

In the large cap space, energy has been by far the best performing sector in the S&P 500, up just over 16% year-to-date. Energy is followed by financials, which has gained 0.39% and is the only other S&P 500 sector in the green this year. On the other end of the spectrum, real estate has been the worst-performing sector in the S&P this year, down more than -8.5%. Real estate is followed closely by technology, which has shed -8.4% in 2022 as the sector has been hampered by concerns about rising rates and stretched valuations as we discussed last week.

Looking at the year-to-date sector attribution for IWM, we see a similar picture of leadership. As in large cap, energy is by far the best performing small cap sector, with a total return north of 10.5%, it is also the only sector that shows positive YTD performance. Like in large caps, financials has been the second-best performing small cap sector in 2022. However, while real estate has been the worst performer in the S&P 500, healthcare has been the biggest laggard in small caps, unfortunately, it is also has the largest weight within IWM at over 17%. Meanwhile, technology has been the second-worst performing sector in IWM, as was its S&P 500 counterpart.

In last week’s piece about tech valuations, we also mentioned the recent bias towards large cap stocks outperforming small caps within the Nasdaq (NASD). Based on the year-to-date numbers, we can see that this bias has not been limited to Nasdaq or technology stocks. Looking only at the headline numbers, it is apparent large caps have a clear advantage as IWM has posted a year-to-date total return of -8.09% (through 1/19), while the S&P 500 Total Return Index (TR.SPXX) is down -4.84%. The bias towards large caps also carries through to the sector level in almost every instance. Out of the 11 macro sectors, there are only two instances – basic materials and real estate – where a sector within IWM has outperformed its S&P 500 counterpart. The largest differential coming in the health care sector, where small caps have lost -16.34%, while the S&P 500 Healthcare Sector Index (.SPHC) is down -6.65%, it is also worth noting that the performance numbers for the small sectors in the IWM attribution are based on total return, while the S&P 500 sector returns are price return, which gives an advantage to the small cap sectors to the extent that any dividends have been paid this year.

Beyond mere performance numbers, we can also see the bias toward large caps is reflected in the fund scores for the individual sector funds in both size groups. The table below displays the Select SPDR Sector funds, representing the S&P 500 sectors next to their small cap counterparts, represented by the Invesco S&P Small Cap Sector funds.

In eight of nine sectors (real estate and communication services have been excluded due the absence of representative small cap funds), the large cap representative has a superior fund score reading; the lone exception is the materials sector where the small cap materials ETF (PSCM) has a slightly higher score than its large cap counterpart, (XLB), 3.27 vs. 3.25. It is also worth noting that the lowest-scoring small cap fund is the healthcare representative (PSCH); the sector that has the highest weighting in IWM and is also the worst performer year-to-date. The Invesco small cap funds are based on S&P small cap sector indexes, while IWM is based on the Russell 2000, so there are undoubtedly some differences in the composition of these ETFs versus the sectors within IWM, however, in both instances there as an observable bias towards large caps.

Overall, there does not appear to be a significant difference in sector leadership between large and small cap. Year-to-date, the energy and financial sectors have posted the best performance within their respective size categories and the energy sector funds have the strongest fund scores within both groups.

However, in the current environment there does appear to be a clear bias toward large caps almost across the board as was reflected in both the year-to-date performance numbers and the scores of the individual sector funds.

The sector allocation of the Russell 2000, and by extension, IWM, also appears to be a significant headwind currently. Its largest sector by weight, health care, has been the worst performing small cap sector year-to-date and the healthcare sector ETF has the weakest fund score reading among the small cap sector fund lineup. Consumer discretionary, which has the second-weakest score posting in the small cap ETF family, also has a relatively large weighting within IWM – 11.27% on average in 2022.

Investors may do well to utilize an alternative weighting scheme for their small cap exposure that emphasizes areas of strength, while significantly underweighting or avoiding some of the weakest areas within the space, which happen to also have some of the largest weightings in the Russell 2000 index.

Alternative markets have been one of the few asset classes to start off 2022 on a strong footing, with muted returns from international equities and pullbacks experienced across domestic equities. One of the major stories in alternative investments this month has been the resurgence in oil, with the crude oil continuous CL/ chart reaching a new 52-week high at $86 in trading Wednesday (as discussed in yesterday’s Alternative Assets Overview). This has helped the broad commodities group climb into the “blue sky zone” on the Asset Class Group Scores (ACGS) page with the recent score posting of 4.01 marking the group’s highest average score reading since 2011. Commodities have remained north of the 3.00 score threshold since April of last year and began to move rapidly higher in late December before ascending to current levels.

The rise in crude oil prices has led to swift score movement from the MLPs group, which rose from a score of 3.15 at the end of 2021 to a recent score posting of 4.41. While this improvement has been notable, MLPs have a tendency to show heightened volatility with a group rRisk score of 2.48. The group is also nearing overbought positioning with the second-highest weekly OBOS average on the entire ACGS system at a recent posting of 79.74%.

There certainly may be actionable areas within the MLP space, however, oil-related funds are not the only aspect of commodity markets to show recent improvement. Agriculture showed improvement alongside broad commodities beginning at the end of 2020 but saw relatively muted movement throughout the second half of 2021. The group pushed higher this week to match the MLP group score at 4.41, marking its highest score since 2011 as well. The agriculture group score direction sits at 1.30, which is among the highest directional moves out of all 135 ACGS groups.

There are limited options for those looking to invest in the agriculture space, but one broad option is the Invesco DB Agriculture Fund DBA. This fund has shown notable improvement on its ¼ point chart, giving two consecutive buy signals before reversing back up into a column of Xs to form another double top at $20.25 in Wednesday’s trading. DBA sits at a favorable 4.53 fund score posting, which bests the average agriculture score (4.41) as well as the average all-US score (3.25), and is paired with a sharply positive 2.63 score direction. Note that DBA does generate a K1 and carries an expense ratio of 0.94%. Those looking to add exposure may consider DBA at current levels, with initial support seen on the ¼ point chart at $19.50.

Daily Option Ideas for January 20, 2022