It's Time for a Reversal in Small Caps

Small caps are under fire for the first time in over a year...

The Russell 2000 Index recently fell 9% in a little over a month. That quick drop has pushed the sector into oversold territory.

We haven't seen this kind of setup since March 2020. And as you probably know, that was an incredible buying opportunity.

It wasn't the only one, though... History shows that buying small caps when they're beat up – like today – is a winning strategy. A 16% gain in small caps is possible over the next year. But you need to act fast.

Let me explain...

"Bottom fishing" is a dangerous way to invest. It's when you look around for "value" in beaten-up areas of the market.

The problem is that falling stocks tend to keep falling. So while it might feel heroic to time the bottom, it's usually a losing strategy.

Instead, what you want to do is find something that's beaten up and buy after prices have reversed. That's where oversold setups come into play.

If you're new to this idea, we're talking about the relative strength index ("RSI"). It's a contrarian tool that lets us see when an investment has gone too far, too fast in either direction.

An oversold extreme often marks a buying opportunity. For example, when an asset falls below and rises back above an RSI of 30, hitting oversold territory, a short-term move higher is likely.

It basically means that a beaten-up asset is begging to move higher... which is exactly what we want to see.

Small caps recently fell below an RSI of 30 for the first time in over a year. Take a look...

This sector has taken a hard turn lower recently. Again, it's down roughly 9% from its June peak through last Monday's close. But history shows that the worst is likely over.

Since 1990, similar setups have happened roughly 1% of the time. And outperformance tends to follow. Check it out...

Not many sectors return roughly 10% per year for three decades. But as impressive as that is, today's setup blows that return out of the water...

Previous extremes have led to 5% gains in three months, 8% gains in six months, and a 16% gain over the next year.

Prices haven't made a huge reversal yet, but they've started to drift higher. That means small caps are a safe bet right now. And the iShares Russell 2000 Fund (IWM) is an easy way to make the trade.

History says you can expect 16% upside from here. So if you're interested in double-digit profits, it's time to bet on a reversal in small caps.

Good investing,

Chris Igou

Further Reading

Stocks have been soaring lately. And although it might seem outrageous to think this skyward trajectory will continue, history tells us there's room to run in the near future... Read more here: You Shouldn't Stress About Sky-High Valuations.

"The bull market in housing is well underway. And what's causing it is no secret," Chris says. A surge in homebuyer demand has elevated the housing sector. This has been a tailwind for homebuilders. And one in particular is even breaking out... Learn more here: A Simple Way to Play the Housing Boom.

Market Notes
THE HOUSING BOOM MEANS FOLKS NEED FLOORS

Today, we’re looking at another winner from the red-hot housing market…

As regular readers know, U.S. housing is on fire right now. We’re seeing massive demand from homebuyers coupled with a record-low supply. And with new builds underway and countless renovations taking place, homebuilders and home-improvement companies have been thriving. This flooring retailer is benefiting as well…

Floor & Decor (FND) sells everything from tile, wood, and stone flooring to installation materials and decorative accessories. With so many folks building or sprucing up houses, business is absolutely booming… According to Floor & Decor’s CEO, many stores have seen record weekly sales in the most recent quarter. In all, the company’s sales were up 41% year over year to $783 million.

As you can see in today’s chart, FND shares are rocketing higher. They’ve tripled over the past two years and recently hit a fresh all-time high. And with the U.S. housing market showing no signs of cooling down any time soon, this uptrend should continue…