Chink In Small-Caps’ Armor

Some early signs of fatigue are showing up on the Russell 2000, which has more than doubled since March. Conditions are extended. A week ago yesterday, the small cap index was 34.7 percent above its 200-day. Although this in and of itself does not mean the prevailing overbought conditions unwind right here and now, this comes at a time when there are hues of speculation in both options and margin debt.

There is a chink in small-caps’ armor. After more than doubling since bottoming at 960s in March, the Russell 2000 (IWM) this week showed early signs of distribution. Monday, the small cap index posted a new all-time high of 2026.24 but only to reverse and close the session down 0.4 percent to 1996.25. This was followed by a 1.8-percent decline on Tuesday and a 1.1-percent rally on Wednesday.

Tuesday’s low of 1950.82 was bought. The 20-day lied at 1933.10 then, and bulls obviously were not ready to lose that average that easy. There is also short-term horizontal support at 1930s (Chart 1). Wednesday, the Russell 2000 (1979.99) closed essentially at the 10-day. Inability to recapture the average will raise the odds that the 20-day will be the next victim, a development that likely shifts momentum to bears’ favor – at least in the short term.

Conditions are extended.

Particularly after bottoming in late October, the index just about went parabolic (arrow). In between, bulls not only reclaimed 1600-plus, which goes back to January 2018, but also 1740s, where it peaked in August that year.

Investors began to gravitate toward small-caps post-November 3 presidential election, and particularly after Pfizer (PFE) and Moderna (MRNA) delivered positive vaccine news – on the 9th and 16th last month, respectively.

The vaccine news has meaningfully raised hopes that the US economy would get back to normal next year. By nature, small-caps are more domestically exposed than their larger-cap cousins, which also have international exposure.

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