This group of stocks could make or break the market rally

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Small cap stocks could soon make a big difference in the broader market.

While the Russell 2000 small-cap index has lagged the major averages, still down more than 10 percent from its September highs, market watchers say its next move will be critical to where stocks go in the next few months.

“The Russell is frequently a very good leading indicator for the rest of the stock market, and we certainly saw that last year when it rolled over much earlier than the rest of the market did,” Matt Maley, managing director and equity strategist at Miller Tabak, said Tuesday on CNBC’s “Trading Nation.”

But the Russell’s recent flattening concerns Maley, who said the index is now pushing up against the 50-week moving average that it broke below in late 2018.

He added that although the 50-week moving average is an uncommon indicator for technicians to use, it has been a reliable level of support and resistance in recent years.

“Now, the 50-week moving average provided unbelievably solid support in 2016, 2017 and through much of 2018,” Maley said. “Old support becomes new resistance, and we’re bumping up right against that line right now. So, [if] it can break out above that line, … it should be able to move nicely. If it fails again, it may roll over in a decent way. So it’s going to be really important what this does because it has been, again, a good leading indicator, not only for [the] domestic economy, but for the broad market overall.”

Mark Tepper, president and CEO of Strategic Wealth Partners, said the Russell could be approaching a downturn.

“When we talk large caps versus small caps, the very first thing that we want to consider is what are the positive catalysts that could move stocks at this point?” Tepper said on the CNBC segment. “The biggest one for me that jumps out is trade, and trade doesn’t mean as much for small caps because they’re conducting most of their business right here in the U.S.”

But large-cap stocks are quite dependent on the outcome of the United States’ trade talks, with more than 40% of the S&P 500’s revenues coming in from overseas, Tepper said.

As such, “the trade catalyst will be great for the S&P, but it will have a minimal effect on small caps,” he argued. “Now, the next concern we have is debt. So, assuming we are in the eighth inning of this rally, we want to hold companies with less debt. Those are the companies that are really going to weather the storm much better in the next economic downturn, and small caps just have way more debt than the large caps do, so that makes us a bit uneasy.”

Tepper even drew a harrowing comparison to the downturn that caused the 2008 financial crisis.

“Most small caps are high-yield companies with floating-rate debt, so as yields eventually go up, that debt service goes up, and that reeks of the interest-only adjustable-rate mortgage crisis that led to the subprime crisis,” he said. “So, I’d say at this stage of the game, the risk-reward setup looks much better in large caps.”

The Russell 2000 ended trading more than 1 percent lower on Tuesday. It has gained almost 16 percent year to date, compared with the S&P 500’s nearly 15 percent gain.

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