iShares Russell 2000 Index (ETF) (IWM) – Beware Small Caps!

The small-cap Russell 2000 index — as represented by the iShares Russell 2000 Index (ETF) (NYSEARCA:IWM) — is higher by nearly 10% this year. This might seem favorable when you consider that the SPDR S&P 500 ETF Trust (NYSEARCA:SPY) is higher by 7% for 2016 thus far. But if you consider the higher volatility of the IWM ETF, plus the lower high it’s trading at versus 2015 highs … well, that takeaway is far from splendid.

iShares Russell 2000 Index (ETF)(NYSEARCA:IWM)U.S. economic data as well as top- and bottom-line growth for U.S. stocks has slowed for the better part of the past year-and-a-half. Yes, the S&P 500 in July managed to push to a marginal higher high versus its 2015 highs.

Yes, this brought about new animal spirits in some investors. But economic gravity is a difficult thing to fight, especially seven-plus years into an economic expansion cycle. Ultimately, economic growth tends to stall, as it already has.

This doesn’t have to end in disaster for stocks. In fact, since the U.S. economy began to slow in the first half of 2015, the S&P 500 has wavered, but is still slightly up.

But the reality of the Russell 2000 and the IWM ETF is that despite the nearly 10% rally, they’re still trading below 2015 lows and are largely stuck in a wide trading range. Volatility also has seen a notable uptick since the summer of 2015, where U.S. stocks have seen two meaningful draw-downs since.

If the Russell 2000 — which much more closely resembles the state of the U.S. economy than the multinational-friendly S&P 500 does — can’t move to new highs, what does this tell us about the state of economic growth?

IWM ETF Charts

My simple takeaway: This is a mirror of a slowing economy.

On the first chart below, I plotted the IWM ETF (using candlesticks) versus the SPY in blue and versus the NYSE Composite. Both the NYSE Composite and the IWM are more diversified equity indices, and as you can see, they’ve both marked their respective charts with lower highs versus the 2015 highs.

While this does not have to get traders all bearish, it should at least serve as a sign that maybe things are not as rosy as your typical Wall Street economist makes it out to be.

IWM vs SPY vs NYSE Composite
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On the daily chart, we see that the IWM ETF has been stuck in a sideways trading range since mid-July. This now has the Russell 2000 sitting at its 2016 support line (purple dotted line) and right at horizontal support (i.e., former resistance), marked by the blue horizontal bar.

A break below this point of around $120 could accelerate downside and see the index tumble back toward its red 200-day moving average around the $113 or $114 area.

Russell 2000 IWM ETF daily view
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There is no reason to over-complicate this. As long as support holds, traders may not want to press their shorts. However, if and when this technical confluence support area breaks, then a trap door could quickly see the Russell 2000 drop about 5% before better technical support comes into play.

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