7 Sessions After Bouncing Off Channel Support, R2K Rallies To Upper End, Resistance Likely

The Russell 2000 (IWM) continues to diverge with small-business profit trend. Having rallied the index 138 percent from the low of last March, bulls are salivating over this year’s consensus profit estimates. In the meantime, on the back foot for nearly 11 months, bears have an opportunity to defend the upper end of a three-month ascending channel.

The Russell 2000 Small Cap Index continues to diverge with small-business profit trend. Historically, National Federation of Independent Business’ Actual Earnings Changes sub-index and the Russell 2000 have shown a tendency to move hand in hand (Chart 1). But this changed particularly since late October-early November last year when two major developments occurred simultaneously.

First was the November 3 presidential election. Optimism around President Joe Biden’s spending plan – both stimulus and infrastructure – was cemented further on January 5 as Georgia Senate runoff races were won by the Democrats, giving them control of both chambers of Congress as well as the White House. Second was the announcement by Pfizer (PFE) on November 9 – followed by Moderna (MRNA) a week after that – of positive vaccine news. This massively raised investor hopes that the US economy would come roaring back this year after a 3.5-percent decline in real GDP in 2020.

Small-caps inherently have more domestic exposure than their large-cap cousins such as the S&P 500 (SPX) Large Cap Index. As the economy suffered a first negative year since 2009, small-cap companies bore the brunt of this contraction last year.

As of last Thursday, with nearly three-fourths of 4Q results in, S&P 600 Small Cap companies were on course for losing $3.73 in operations in 2020, down from earnings of $30.68 in 2019. This is probably what is captured in NFIB’s Actual Earnings Changes sub-index, which deteriorated from minus 14 to minus 16 in January. After collapsing to minus 35 last June, the metric improved to minus three in October before it started to go downhill again (Chart 1).

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