Market timers often watch small caps for clues about possible trend reversals, but thus far the Russell 2000 Small Cap Index is going strong. Here’s a closer look at seasonality and support/resistance levels for the Russell 2000.
It’s said that major market tops are often preceded by weakness in small cap stocks. This premise makes sense, as small cap stocks are most sensitive to the ebb and flow of liquidity. As a liquidity gauge, small cap indexes like the Russell 2000 could be the canary in the mine.
The truth is in the pudding. Does this theory hold up against the facts? The chart below plots the S&P 500 Index against the Russell 2000. I guess the key point is how you define a “major” market top.
Small cap weakness foreshadowed the 2007 top, but wasn’t obvious at the 2010, 2011, and 2012 highs (at least not on the weekly chart).
What about today? Small caps are going strong and the canary is chirping and frolicking.
The second chart provides a closer look at the Russell 2000 (corresponding ETF: iShares Russell 2000 ETF – IWM).
The Russell 2000 climbed back above the green trend line originating at the October 2011 low.
Recent prior peaks supply various resistance levels (red lines) and today’s decline drove prices below the green November 15 support line (an early warning signal), but starting in mid-December small caps tend to outperform large caps. January is one of the strongest months for small cap stocks.
Historical seasonal patterns suggest that more strength lies ahead for small caps. Technicals support this view. This may drive small caps to new all-time highs (less than 4% away), but I doubt it will be enough to push the Dow and S&P to all-time highs. A break below technical support at 836 (green trend line support) would warn that this year is different.
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