Nothing worries stock traders more than rate increases from the U.S. Federal Reserve.

The Fed has implemented 10 of them since March 2022. These increases have taken the Fed Funds Rate from nearly zero to 5.25%.

After hitting the pause button at its most recent meeting, it’s quite possible the Fed will raise rates one more time in July. And it’s likely the central bank will justify the rate hike either as being “insurance” or saying that there is “still plenty of work to do.”

Whatever.

I’m not sure what numbers the Federal Reserve is looking at to make it think more hikes are necessary.

The Produce Price Index (PPI) and the Consumer Price Index (CPI) are falling. Jobless claims are on the rise — as are bankruptcies.

We’ve had bank failures and are seeing housing starts and apartment rental applications slow down. At the same time, the number of commercial real estate defaults continues to steadily climb.

2 Rate Hikes Are Better Than 10

If the Fed sticks to the script, it will likely raise rates two more times: (1) at the Federal Open Market Committee (FOMC) meeting next week and (2) at a later meeting before the year is over.

In the market’s eyes, two rate hikes between now and December are better than 10 more.

Wall Street began to have that sentiment late in 2022.

And that has delivered a very profitable bull market — which I predicted, based on historical precedents and the market’s technical posture at the time.

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By January, the bottom was in, and the market hasn’t looked back.

In February, I wrote that small-cap stocks — usually among Wall Street’s most unloved groups — were likely to deliver the goods at some point in the cycle.

That point is now.

Large Caps Are Extended

I am not bearish on tech stocks, large-cap stocks, or artificial intelligence (AI). But anyone who’s invested in these sectors over the last few months knows those stocks have come a long way.

Moreover, even though AI may be in the early stages of a multiyear bull market, there will be pullbacks along the way.

Many of them may be significant.

The Invesco QQQ Trust (NSDQ: QQQ) has gained nearly 50% since its final bear market bottom in January 2023.

But here’s the thing. At some point, profit-taking in QQQ and related areas of the market will begin.

In my opinion, the likelihood of that profit-taking leading to an opportunity to buy the dip is better than 50/50.

But that dip may take some time to develop.

Meanwhile, you can already see that money is moving into small stocks as investors look for value.

What Makes Small Stocks Tick?

The small-stock universe is composed of companies whose market capitalizations are generally below $4 billion to $5 billion.

This is based partially on the market’s perception of the earnings potential from products or services these small companies offer — as well as on what Wall Street’s prevailing promotional machine is doing at any given moment.

It’s easier to sell Alphabet (NSDQ: GOOGL), Apple (NSDQ: AAPL), and Microsoft (NSDQ: MSFT) than it is to sell a small company with good management that delivers steady earnings and whose growth prospects are not as dependent on the Fed, geopolitics, volcanic eruptions, meme trends, UFO sightings, or the latest reported Sasquatch sightings.

That’s why a smart way to invest in the sector is via an ETF such as the iShares Core S&P Small-Cap ETF (NYSE: IJR).

The price chart above shows that IJR bottomed out with the market in October 2022 and quickly underperformed as the AI firestorm ignited.

AI is sexy; steady earnings and good management are just “meh”!

However, lately, IJR has broken out to a new high. “Meh” is gaining ground.

Comparing Money Flows

Loyal readers know my bent toward technical analysis.

Yet as I’ve shown here many times, price chart analysis is often what tells us where money is flowing.

Guess what? Money is moving into small stocks, and it is QQQ that is getting extended.

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Let’s look at four technical indicators on both above charts.

Accumulation Distribution Indicator (ADI)

This is a great way to measure where short sellers (investors betting on falling prices) are positioned.

• For QQQ, the ADI line is still in an uptrend after bottoming out in October 2022.
• For IJR, we see that after an initial rise in October, the short sellers got one last victory in January 2023. Since then, they’ve abandoned the ship as the ADI has risen.

Both are bullish.

On-balance Volume (OBV)

This indicator tells us what actual buyers and sellers are doing.

• For QQQ, we see that both OBV and ADI bottomed in January and have moved steadily higher since.
• For IJR, we see a bullish continuation in the rising trend for ADI like that in QQQ. Short sellers are bugging out, which is bullish.
• OBV for IJR has just broken above its previous high. That’s a sign that conviction on the part of buyers is increasing. That’s more bullish.

Volume by Price (VBP)

Those big bars on the left hand of the price charts are what I call my “tie-breaker indicator.”

Each bar measures the amount of trading activity (buying and selling) that occurs at any price level. When prices move above or below a certain bar or — even better — a cluster of bars, it usually indicates that prices are about to accelerate in that direction.

You can see that the VBP bars for the current price area of QQQ are very small. That means that there are few buyers or sellers in the price area where QQQ is trading ($380-ish).

In this case, the first big bar is around $320, although there are some bars around the 20-day moving average, which is short-term price support.

By contrast, you see that IJR has support just below its current price at $102 where the top of that VBP cluster is sitting.

If there is a price correction, support will likely be where the biggest bars are located. IJR has a better support structure than QQQ.

Bollinger Bands (BB)

A final review of the charts shows that QQQ is now trading above its upper Bollinger Band (BB) (the green flexible bands above and below the prices).

This is a sign that the trend has gone too far to the upside and that a so-called “reversion to the mean” — in this case, the 20-day moving average — is on the way.

Moreover, the RSI indicator for QQQ, which measures the overbought/oversold status of a stock, is above 70. This is an overbought reading.

Think of “overbought” as overheated and in need of cooling off.

For its part, IJR has just tagged its upper BB but is not as overheated as QQQ since it ducked right inside the channel.

The Bottom Line

You may say I’m grasping at straws. And any technical analyst worth their salt will admit that price chart interpretation is often more art than science.

Yet in retrospect, even subtle signs are often proven to be correct. In real-time, things are more fluid.

Certainly, the rally in QQQ, AI-related stocks, and IJR can go much higher. It is equally possible that the rally may stall.

That moment happen as early as Mr. Powell’s post-FOMC meeting press conference on July 26.

Beyond that, the bread crumbs being left by the smart money (OBV and ADI) suggest money is quietly moving into small stocks, while large tech stocks are increasingly overbought and in need of a rest.

This makes sense because it’s hard to justify buying into QQQ after a nearly 50% gain in seven months.

Meanwhile, the small stocks are still carving out the last stage of what could be a long-term base — which may be a prelude to a significant breakout.

Barring the Fed delivering some sort of nuclear attack on the market, the most likely scenario is that QQQ will consolidate while IJR moves steadily higher for the next few weeks once the dust settles after the Fed’s next rate hike.

That doesn’t sound so “meh” after all.

Editor’s Note: Investing Daily’s Dr. Joe Duarte just provided you with valuable investing insight. But we’ve only scratched the surface of our team’s expertise.

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Jim Pearce is the chief investment strategist of our flagship publication, Personal Finance. Jim has found the optimal way to cash in on the artificial intelligence (AI) super-boom. It’s an obscure “picks-and-shovels” play that you won’t hear about on CNBC.

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