So, every time we have been at a critical juncture in the past, these make-or-break moments the Russel 2000 has failed around these levels. Now understand that it has underperformed the major averages mightily and even when it moves higher in many regards, it is getting pulled along for lack of a better phrase.
Take just over the last 6 months, the QQQ Trust is up nearly 100% more than the Russel, 20% vs 10%. Now this is where things get fascinating though as over three months, we have seen the Russell 2000 outperform the QQQ Trust by about 3%. So, there is a good amount of churn under these markets and it’s true, the Russel is only up 1.50% this year so far compared to the QQQ Trust being up over 6%.
That said, right now, I feel we could be at a turning point where, possibly, in a few months, we could talk about Russel's out-performance.
Now this is a big IF, but we are at the inflection point on the index. So once again it is make or break, pass or fail, all grades are final. So, if we a breakout over this multiyear high you see below in the weekly chart, it sure looks like the next stop will be $220 and that’s about an 8% move from here. Looking at the chart below, I like the strength in the RSI, and it has shown resilience around the trend and averages, which on the weekly chart it’s been the 17-week EMA.
While the large caps and the QQQ have had the run of a lifetime, that usually means one of two things that meet the same endpoint. Which is the index’s moving back in line with more historic norms as performance moves toward normalization. So, if that’s the case and this rally has legs and more time to run, we will probably see the small caps, the high beta stocks making a comeback. Now, just to put things into context, we have exited a long-term low interest rate environment, while the 40-year bond bull market has ended. This has created ripples through many small caps, decimating varying sectors with slower growth than was expected. Never mind the high cost of capital with interest rates soaring, these companies have never seen this type of operating environment.
Looking at a chart of both the QQQ Trust with the Russel 2000 on the bottom, we can see how the divergence in performance really started getting going in March 2023. What I find to be the highest probable event at this current time is a breakout in small caps in the weeks ahead as many large caps take a breather. If this rally is to continue on, this is an important pillar for a proper foundation for future equity gains. Now the flip side is we may have another down leg if the Russel falls apart again at these levels.
The reality is we haven’t seen this type of environment for companies to navigate in quite some time, literally never if one considers getting off the zero bound of interest rates. The point here is small caps lagging, in the AI driven world we have been taking over by is understandable. Also, it’s clear where the money is flowing into, but at this point I would push back against the moves and say, while I surely don’t think we hit a top. The gains from now on won’t look like the gains we had over the last year. They will be more of a grind for many large caps, and I would expect the equally weighted indexes to perform well in contrast.
Now that being said, this is in a bullish scenario, and while currently I have a bias toward this thesis. There are many other factors to consider. One would be the risk of a recession and rates collapsing, but also dragging down the economy. This would be a dangerous situation for many occupants in the Russell 2000. Also, if rates stay elevated, and don’t drop as fast as many assume in 2024, we could get a significant selloff. With the equity market singing to its own tune, one can lose a shirt when the music stops. So, exercise caution and only take risks with what you can afford to lose. Calculate your exposure and make sure you are within your limits. If these scenarios truly play out in the extremes, they could hinder the path of the Russell 2000 in epic fashion.
Now, putting this aside, let’s get into the nuts and bolts of some ways to trade this. Personally, I bought the Russel in my trading accounts today. I went out and bought some March 15th $200/210 calls spread and April 5th $210s naked (Reference around $203). This is ahead of the PCE tomorrow, which could be an event to trigger a pivotal move. If that’s up or down, it is yet to play out, but the action, and the technical picture show I should take a trade on the long side. For that reason, I took a $200/210 vert call spread.
Max Risk $4.50 buying 1 $200 contract for $450 and selling the $210.
Max Gain $9.50 with 1 Contract $950
Trade expires March 15th.
Looking at the one month 30-minute chart, we have a solid trend going and I expect for this to continue. If consolidate afterward, that’s fine, but I don’t want to be holding on a breakdown under $197. I will probably look to sell on any break under $199, which is near the slope of the trend over the few months. Surely if the momentum breaks and we move lower, this trade will be a bust in most of the probable outcomes by then.
Now take a look at a 6-month daily chart with the major support levels. We can see how a move back to $200 could be expected but with the slope of averages and trend with the convergences. I don’t want to see much trading under $200 for this trade to stay profitable. If I didn’t think such a big move could be coming. I would wait for a better entry. That being said if we get a move lower on the economic news tomorrow there could surely be a great entry still yet to be had.
Now on the upside I will be looking for a move to $220 on a breakout but will start to consider selling on a move to $210. I will either sell my naked options outright or sell the April 5th $220s to create a $210/$220 vert if we breakout and hit $210 in coming days and weeks.
Russell 2000 Sector Weighting
Russell 2000 Top Holdings
Conclusion
With the Nvidia earnings having come and went I feel a lot of the hype trade has fizzled out and the odds for consolidation and a pullback are rising. So, there is some caution I preach at these lofty equity market levels.
We could very well move sideways within a few percent range for a while and this Russel trade could be just another short at these levels like the many times it has over the past few years.
That said, I think the odds are on the bull’s horns at a roughly 58% chance for a breakout move higher in the Russel 2000 within the next few weeks if not days. If the trade is a bust so, be it, but I’m in and ready for whatever outcome is awaiting.
Have a great week everyone. Take care.
Eric
I have been long small caps also. It has been a bit frustrating but hope we finally take off!
Russel futures up nicely this morning after PCE data. Good call!