Stocks entered an official correction earlier this month.
The S&P 500 Index fell 10% from its high – for the first time since October 2023.
The decline has investors spooked. Fear is running wild in the markets. But the S&P 500 only tells part of the story.
Another group of stocks nearly entered a bear market. This part of the market recently dropped as much as 18% from its recent high.
It's due for a reversal, though. This group has fallen too far, too fast. This setup tells us that a reversal is likely. And we could see 17% upside over the next year.
Let me explain...
Life was good in February. Stocks were hitting new all-time highs. And while there were concerns out there, the market continually shrugged them off.
In the past month, the market abruptly priced in all of those fears.
The decline was bad for large-cap stocks. But small-cap stocks took an even worse beating...
The Russell 2000 Index – the benchmark for small caps – dropped double digits in just a few short weeks. And again, at its worst, it traded 18% below its high from late November... putting us darn close to a small-cap bear market.
But the drop is overdone. We can see it through the relative strength index ("RSI"). This indicator looks at recent price changes and tells us when an investment has moved too far, too fast.
When a decline gets too stretched, it shows the asset is "oversold." A snapback rally usually follows. And that makes the RSI a useful contrarian indicator.
An RSI below 30 is considered oversold. And the Russell 2000's RSI recently plunged to 24. Take a look...
The Russell 2000 crashed. But according to the RSI, this move is likely overdone... And small caps are likely to rebound from here.
History agrees. To see it, I tracked what happened with small caps whenever the RSI made similar moves... specifically, when it fell below 25 and then rose back above that level.
We've seen 27 similar setups over the past 46 years. And according to history, those were darn good times to buy. Take a look...
Small-cap stocks have been a good long-term investment. Using a typical buy-and-hold strategy, they've grown 8.7% per year since 1979. But if you bought after an RSI setup like we have right now, you could have done much better.
Similar instances led to 6.7% gains in six months and 17.4% gains over a year. Plus, the Russell 2000 was up a year later 70% of the time.
That's major outperformance. And it shows we need to remember something important right now...
Fear is running the show today. But when stocks fall – and especially when they fall fast – you can always find opportunities.
It's hard not to freeze when a correction is underway. But according to history, small caps could see a solid gain over the next year... making this sector a smart bet.
Good investing,
Brett Eversole
Further Reading
Right now, mom-and-pop investors are almost as bearish as they've ever been. For us, this is a great contrarian indicator. Previous readings like this have led to historic outperformance – not for a single stock or sector, but for the overall market... Read more here.
"We aren't seeing a black-swan event today," Sean Michael Cummings writes. If you've been following the news, it might not feel that way. But the sell-off we've seen isn't a full-blown market crash yet because we're still missing a key ingredient. And until that shows up, now could be a great opportunity to buy the dip... Learn more here.
