“The stock market is doomed because small cap stocks are trailing behind the S&P” has been the financial media’s message. Obviously the market is doomed eventually, but for now this piece of Wall Street “wisdom” hasn’t paid off. Here’s what the Russell 2000 is telling us.
Small Cap stocks represented by the Russell 2000 and ETFs like the iShares Russell 2000 Index ETF (IWM) have received their fair share of media attention lately.
The focus has been on the under performance of the Russell 2000. This has been considered bearish for the S&P 500 (SPY), Dow Jones (DIA), and Nasdaq (QQQ) since small cap stocks are often viewed as a barometer for the market as a whole.
The Profit Radar Report has been promoting an individual and independant analysis of small caps, financials (XLF) and the Nasdaq to get a better read on the big picture.
One detailed piece of analysis has shown that under performance by the Russell 2000 is not necessarily negative for the stock market.
There have been nine occasions over the last 20 years where the S&P was within 1% of a multi-month high (1,392 on July 30) while the Russell 2000 was more than 5% below a multi-month high (820 on July 5). This led to small negative returns only three times.
Even though the whole lagging Russell doom scenario is busted, the Russell broke above key resistance. This happened on August 7, with a close above 800 (a day before XLF broke above resistance at 14.85).
Although the Russell was still lagging the S&P, this break was important and signaled more gains for small caps (financials) and the overall market.
The chart below plots the S&P 500 (SPY) against the Russell 2000 (IWM) and reveals divergences at various degrees.
In May 2011 the Russell 2000 Index recorded an all-time high. The S&P did not. Since then the S&P has nearly reclaimed its 2012 high while the Russell 2000 is about 5% away.
The S&P 500 is about 10% away from its 2007 all-time high, while the Russell 2000 is only 6% away from its 2011 all-time high.
If you are looking for a divergence between the S&P 500 and Russell 2000, you’ll find more than just one, some bullish, some bearish.
The chart below shows immediate resistance for the Russell 2000 and S&P 500 Index (red lines) and short-term support. There are indicators that suggest an upcoming sell off, but as long as prices remain above short-term support (green lines) the trend is up.