Yesterday I had mentioned the possibility of an upside correction for small caps manifest in the Russell 2000, and this looks to be continuing into today.  There has been some discussion since then, with many suggesting that the correction over the last few months has been the other way around. 

    I think that the argument they provide is fundamentally flawed.  Small caps have consistently outperformed large caps for a reason, and this reason is exactly the same reason that bonds are consistently outperformed by large caps - simple risk premium.  Given the higher volatility and chance of large loss, small caps *must* have higher returns, otherwise no one would invest in them.  To suggest that large caps' returns should be equal to that of small caps would imply that there is no fundamental risk reduction in capitalization size, an obviously suspicious statement.

    Though a great earnings season, share buybacks, and buyouts might have changed the dynamics of the cash flow for the past month, I would not expect the trend to continue throughout the year without at least slowing significantly from the present rate.

    For reference, here's the 5-session chart, as well as the 1-month chart.  As you can see, IWM has broken from equal to 2% above both SPY and DIA.

    If you believe that small caps must have a higher return YTD than large caps in the near future, then expect to see dramatic moves from the Russell 2000.  Even if you only expect the Russell 2000 to catch up to the S&P, there is still at least another 1% to the upside.