Stocks began the week unsettled as investors awaited the kickoff to earnings season, but one analyst already sees the next big catalyst for the market.
Oppenheimer head of technical analysis Ari Wald said Monday that a breakout in small caps should give the rest of the market the "firepower" necessary to close out the year on a high note.
"The small caps represent the part of the market that has been in this internal correction that the market has endured really since the second quarter. Consider that the Russell 2000 is now flat for the last eight months. That's a long time with very little progress in this very important market gauge," Wald told CNBC's "Trading Nation."
"It prompts the question — is it an opportunity or a concern? We do think it's an opportunity, given our view of where we are in the equity cycle. We think we're about 18 months into what is typically a 30-month cycle so we think this bull market has further to go," he said.
Wald needs to see the small cap-focused Russell 2000 break above its March high to signal a "re-broadening of participation" in the market. He expects bullish seasonal trends to help support this in the fourth quarter. The index hit a record high just above 2360 in mid-March. However, it's now down 6% from that peak.
"It's this breakout potential for what you would call the 'market soldiers' that equates to the firepower that we see for the markets broadly going into the first half of 2022," Wald said.
Small caps are generally more sensitive to broad economic forces given their size. A smaller company is less able to absorb headwinds such as rising costs, for example. If they are outperforming, it suggests the economy is doing well.
New Street Advisors founder Delano Saporu only has minor exposure to the small caps, but says the strategy to diversify makes sense.
"I do think for investors, it makes sense to have exposure when it comes to the Russell 2000 to the smaller cap, higher growth potential," Saporu said during the same interview.
Small-cap growth stocks have largely underperformed the rest of the group this year. TheiShares Russell 2000 Growth ETF is up just 2% in 2021, even as the Russell 2000 has climbed 12%.
While he does have a small position in the Russell 2000, Saporu is sticking with large-cap stocks, especially if earnings season surprises to the upside. He told CNBC in a separate email that an overweight position in large caps should insulate against any volatility in the small caps.
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