Relationship Between Small and Midcap Stocks

from Dr. Brett:
My recent Trading Markets article took a look at how small cap performance acts as a mediator of past and future S&P performance, creating a statistical interaction effect. Today we had an interesting situation in which the S&P Midcaps ($MID) underperformed the S&P Small Caps ($SML). Specifically, SML was up .03% and MID was down -.34%.

Going back to March, 2003 (N = 766), I found 127 occasions in which the day's change in SML was within plus or minus .20%. The next day in SPY averaged .01% (63 up, 64 down), which is weaker than next day results for the sample overall. Once again, however, we see an interaction effect. When SML is neutral and MID is strong, the next day in SPY averages a loss of -.11 (29 up, 35 down). When SML is neutral and MID is weak, the next day in SPY averages a gain of .13% (34 up, 29 down).

Once again we see that a critical mediating effect is played by the relative outperformance or underperformance of the small cap stocks. When SML is neutral but outperforms MID, next day results in SPY are more favorable than when SML is neutral but underperforms MID. Score this as a mild bullish consideration for tomorrow.