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Get Ready for a Breakout in Small Caps

Smaller companies are in good position to keep climbing higher


There has been a never-ending stream of questions plaguing the market going into the Federal Reserve’s interest rate announcement. Will the Fed raise interest rates? Or will the decision be pushed back yet again? If rates are increased, where should you invest? If rates aren’t increased, where is the best place to put your money?

The list goes on and on.

As we approach the big moment, one area I’ve been keeping an eye on is small caps and the Russell 2000. While I can’t make any final conclusions until after the Fed’s announcement, I will say that the Russell is looking pretty good right now.

Small-cap stocks performed well through the first half of the year, with the Russell climbing to an all-time high of 1,296 on June 23. But in the volatility that swamped the market this summer, small-caps were hit hard, causing the Russell 2000 to fall as low as 1,102.58 on August 26 — a 15% pullback from its high.

What the Charts Say About Small Caps


Three weeks later, the index is still nearly 10% off its highs, but the bounce back up above 1,170 has caught my attention. The Russell is closing in on a few resistance levels it needs to break through before it’s off to the races once again.

The first big test was a close above 1,170, which we saw on Wednesday on the back of continued strength. The next test will be a close above 1,190, and the Fed will clearly be a factor in whether that happens and how quickly.

In addition to their recent strength, another reason I’m watching small caps is because they generally have most of their sales and profits here in the U.S. This greater domestic exposure makes them less affected by the stronger dollar and currency issues that have weighed on multinational corporations. That exposure would remain a consideration if the dollar were to strengthen more amid rising interest rates.

I’m looking for some wild knee-jerk reactions to the Fed meeting, and then the start of a year-end rally. Of course, you always need to be aware of higher volatility in small caps, but given the Russell 2000’s recent move and the fact that it remains well off its recent highs, there is some real potential upside here.

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