Small-cap stocks (as represented by the Russell 2000) have been underperforming their large-cap peers all year. Through a technical lens, however — and as what could be an unwelcome surprise to the smart money crowd — the index increasingly looks like it has potential to outperform in both absolute and relative terms into early January.
Investors who have been (rightly) cautious on small-cap stocks all year have pointed to the slowing rate of growth both domestically and internationally, as well as the late cyclical nature of the current bull market. This would mean the more volatile and economically sensitive small-cap stocks should show relative weakness at the least. Indeed, the Russell 2000 has jumped in and out of the black all year and still lags the broader indices handsomely in 2014:
- 13.75% for the S&P 500
- 9.75% for the Dow Jones Industrial Average
- 3.75% for the Russell 2000
With the most recent massive two-day stampede higher, however, the Russell 2000 has once again crept into the positive for the year. And considering the forces at work, it could see further gains in coming weeks.
Three non-fundamental but important forces are currently at work that could lift small-cap and large-cap stocks alike in coming weeks:
- Fund managers whose products are lagging their benchmark indices and thus have to make up lost ground to not lose their jobs tend to go performance-chasing.
- Come early January, institutional investors will be looking to put new money to work, which can have the effect of lifting the entire market for a few days to a few weeks.
- The November-April period tends to be seasonally strong for stocks.
Russell 2000 Charts
Looking at the multiyear weekly chart of the Russell 2000, we see an index that continues to hold its 2011 uptrend on a monthly closing basis (in other words, we have to ignore the breakdown scare and V-shaped reversal from mid-October). Directional momentum as represented by the Relative Strength Index at the bottom of the screen is also lifting back up, and all of this is increasingly pushing weight against the diagonal resistance line (upper black line).
A break past this line could get smart-money folks that are short or underweight small-cap stocks scrambling and could lead to a sharp pop, however short-lived.
On the daily chart, the Russell 2000 has, as a result of lackluster sideways trading all year, traced out what could be looked at as an inverse head-and-shoulders pattern, which per definition resolves higher. The so called “neckline” of this formation is the black diagonal resistance line.
There is no reason to overcompliate this, but the Russell 2000 over the past month-and-a-half has essentially churned below this resistance line and with Thursday’s rally actually scored a marginal breakout on the daily chart. Very simply, active investors and traders could consider establishing a long position here in the iShares Russell 2000 Index (IWM) near 1,192 for a near-term move toward 1,230, while any bearish reversal would call off the trade until another breakout sets up.
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Download Serge’s trading plan in the Essence of Swing Trading e-book here. As of this writing, he did not hold a position in any of the aforementioned securities.
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