We are only four trading sessions into the new year and the Russell 2000 — as represented by the iShares Russell 2000 Index (ETF) (NYSEARCA:IWM) — has already fallen more than 6%.
It has been an ugly start to the new year to be sure, but it might just be the beginning of a much more volatile year ahead. The U.S. economy currently finds itself in the seventh year of a cyclical expansion, and the statistics for the eighth year of a presidential election cycle are coming in weak at best. Global risk assets are at risk of some major swings this year.
With the Russell 2000 being the best equity market proxy for the U.S. economy, the IWM ETF should be closely watched as a sign for things to come.
Both the relative and the absolute weakness in price action of the Russell 2000 compared to the S&P 500 is nothing new. While the S&P 500 closed fairly flat for 2015, the IWM ETF was lower by about 6% in 2015. So, why is the Russell 2000 a better proxy for the U.S. economy than the S&P 500? While between 30% and 50% of revenues of companies in the S&P 500 comes from overseas, the vast majority of sales of Russell 2000 component companies are from within the U.S.
Without further ado, let’s get right to the interesting stuff — namely, that big-picture multiyear weekly chart of the Russell 2000.
Russell 2000 Charts
On the chart, we see that while the sharp rally off the 2008 lows continued into its ultimate top last June, the upside momentum as represented by the Relative Strength Index at the bottom of the chart topped out in late 2013. The price action that accompanied the waning upside momentum has since traced out a very notable and bearish head-and-shoulders pattern.
The “head” of the pattern represents the overshooting move last spring into early summer, and the “neckline” is marked by the black diagonal line. A measured move lower from this pattern, using technical analysis 101, would see the IWM fall into the low $80s to high $70s through a 12-month time period.
As such, active investors and traders tactically would be well advised to sell the rallies in this index in 2016.
Speaking of rallies/bounces, or looming rallies, while the above chart paints a decidedly bearish picture for the Russell 2000, the IWM etf in the near-term looks increasingly oversold and ripe for a bounce. In other words, while more proactive traders may try to play a near-term bounce in the index, active investors with more risk aversion should exercise some patience for a bounce in the index to sell or short into for better reward to risk.
On this same chart it is also worth pointing out that during the autumn rally the IWM etf found resistance at the 61.8% Fibonacci retracement line of the sell-off from the summer top into the September lows.
A next measured downside price target from this pattern, through a multi-month lens is in the high $90s.
Like what you see? Sign up for our daily Beat the Bell e-letter and get Serge’s investment advice delivered to your inbox every morning!
Download Serge’s Latest Report: Major High-Flyer Stock to Correct as much as 40% in 2016.
