Why weakness in small caps may be a short-term setback

Fairlead's Katie Stockton charts the next move for small caps

Small cap stocks may be on the cusp of a turnaround.

According to Fairlead Strategies market technician Katie Stockton, the Russell 2000‘s underperformance so far this year is likely a near-term setback.

“We’re kind of convinced that we’ll see small caps do better. Maybe they don’t outperform strongly. But a better year for them after what was a very difficult year for them because breadth was so weak, ” the firm’s founder and managing partner told CNBC’s “Fast Money” on Wednesday.

So far this year, the Russell 2000 is off two percent. Meanwhile, the S&P 500, Dow and Nasdaq 100 have hit new all-time highs.

Stockton believes the Russell 2000’s decline has shaken investors’ confidence in small caps.

‘Short-term oversold condition’

“We want to sort of re-instill that confidence because we’ve seen an initial reaction to a short-term oversold condition — that’s IWM or the Russell 2000 ETF,” she said. “With that, we have improvement in relative performance: Long-term downside momentum versus the S&P 500 has improved.”

The Russell 2000 is coming off a strong fourth quarter. It rallied by almost 14% in that period.

“For IWM, we saw a pretty major trading range breakout in Q4,” Stockton said. “It’s something that we had anticipated because there were some positive divergences in momentum as it had gone sideways with a ton of volatility.”

CNBC’s Anna Gleason contributed to this article.

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