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While the S&P 500 powers through rising bond yields and higher crude oil prices, one section of the U.S. stock market is falling behind: small caps. At the start of the month, the Russel 2000 was up 20% year to date, beating both the S&P 500's 13% gain and the Nasdaq-100's 17% advance. But September has meant big pain for small caps, with the Russell 2000 now only up 14% year to date, versus respective returns of 20% and 12% for the S&P 500 and Nasdaq-100. The culprits seems clear: higher interest-rates and falling bond prices. The correlation between the iShares Russell 2000 ETF (IWM) and the 20+ Year Treasury Bond ETF (TLT) is currently 0.51, compared to 0.29 with the State Street SPDR S&P 500 ETF Trust (SPY) and 0.1 with the Invesco QQQ Trust. Last week, the correlation between small-caps and the price of the 10-year note touched a one-year high above 0.97. "Small caps have had a more difficult time adjusting to the Fed's hawkish turn and continued increase in rates at the long end, evidenced by the fact that their negative correlation to the 10-year Treasury yield is two times that of large caps," said Kevin Gordon, head of macro research and strategy at the Schwab Center for Financial Research. Options trading around the IWM suggests the rate-driven shift in power rankings for the equity indexes can hold. More puts traded than calls in IWM on Thursday, while the volume ratio in SPY was close to even and calls outnumbered puts in QQQ. Volume in SPY and QQQ options was 40% above the 30-day average by midday Thursday, while volume in IWM was almost double. Traders likely bought 480,000 puts, compared to 371,000 calls, and total open interest in puts is now just shy of 7 million contracts, compared to 3 million in puts, Cboe LiveVol data show. Of the total $322 million in premium traded in IWM Thursday, $100 million was likely spent buying puts, compared to $50 million likely spent buying calls, according to SpotGamma data. At the same time, there were also some big put-sellers in the market, with more premium tied to likely put sales than purchases. Still, the top-four most popular trades bought by volume were all puts, with the 280 and 281-strike puts expiring Thursday accounting for over 120,000 trades. The 269-strike put expiring Oct. 16 was the next most popular trade. That contract needs a 4% selloff to make money. "There is probably some more weakness to come if rates continue to move higher, but from a broader perspective, I wouldn't discount the still-strong fundamentals that some small caps are showing. Consistent with the continued improvement in PMIs and the US growth data, forward earnings estimates for small caps continue to look solid," said Schwab's Gordon.
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