Talking Numbers

Think it can't get worse? Here's why it might.

Think it can't get worse? Here's why it might

The markets are off to their worst start to an October in three years, and if the price action of an overlooked part of the market is to be believed, it's about to get worse.

Until last month, the mid-cap S&P 400 was neck-and-neck with the large-cap S&P 500 index and well ahead of the Russell 2000. But recently, the mid-caps have started to trail the broader market. While not yet in correction territory like the Russell 2000, the mid-cap index is taking on the chin; it's down 4 percent in the past 30 days.

And if the charts are any indication, it's about to get worse.

"The best thing you can say about the mid-caps is, hey, at least it's not the Russell 2000," said Richard Ross, global technical strategist at Auerbach Grayson. While that may be the case, he points out, the S&P 400 still trails major market indices like the S&P 500, the Dow Jones Industrial and Transport averages, and the Nasdaq Composite index on a year-to-date basis.

(Watch: Scary October start for stocks; Russell in correction)

Ross is particularly concerned the ETF that tracks the S&P 400 mid-cap index (trading under the ticker symbol MDY) began to form the beginning of a bearish double top pattern over the summer.

"That's a big problem," explained Ross, a "Talking Numbers" contributor. "When that comes at the tail end of a multiyear move like we've seen here in the mid-caps, that spells trouble."

But what also is problematic for the MDY, according to Ross, is that it broke below its 200-day moving average this week, the first time since November 2012.

"Now of course we've seen these buying opportunities before as we've tested and held that 200-day," Ross said. "But in this case, we're extending those losses… Should the mid-cap ETF remain below that long-term moving average for a matter of days – or a week perhaps – that's going to tell you that the bigger trend may have reversed to the downside."

Despite the selloff, however, one portfolio manager sees this as a buying opportunity. Erin Gibbs, equity chief investment officer at S&P Capital IQ Equity Research, thinks the under-loved mid-caps may soon shine.

(Watch: Potential for 500-point drop next month: Trader)

Gibbs, who has over $13 billion in assets under advisory, recently published a study on the S&P 400 showing that the mid-cap index has done better than both the S&P 500 and the small-cap S&P 600 for much of the past 10 years on a risk-adjusted basis.

So while the S&P 400 index is down a lot this past month, Gibbs sees an upshot: The mid-caps just got cheaper.

"The relative outperformance of the large-caps recently is really because of global macro concerns and basically people shifting their assets into what they consider relatively safer global assets," Gibbs said. "However, the mid-caps have been able to hold at about 18 times forward earnings even while earnings growth continues to be ratcheted up."

Of course, that doesn't mean the mid-caps will outshine the broader market immediately. Instead, Gibbs believes it will take a three or four months while the market gets a better sense of the Federal Reserve's next move and while Europe tries to sort out its economy. Once that happens, she said, funds will flow back into mid-cap stocks.

"That's where we can really see the takeoff in mid-caps because they really do offer a significant amount of more growth with lower volatility," she added.

To see the full discussion on mid-cap stocks, with Gibbs on the fundamentals and Ross on the technicals, watch the above video.

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