There has been much debate over where Small-Cap equities will go next. The Russell 2000 is currently hovering around resistance at the 1590 level. Performance wise, it has been a ‘tale of two halves’ for Small-Caps so far this year. Through the first two months of the year, $IWM outpaced the other three major US indices ($SPY, $DIA, and $QQQ) by a handsome margin:
From the Christmas Eve lows until March 1st, the Russell 2000 ($RUT) ran from 1270 to 1590, representing a gain of roughly 25%. Since then, the index has been unable to move higher. We are now back to those levels, after a small correction (which was arguably part of a longer-term consolidation) in late March. So, the question is, can Small-Caps finally breakout?
Small cap chart is important right now – trying to breakout – would reflect further strength. pic.twitter.com/XhTiuCzaQ6
— Strategas (@StrategasRP) April 24, 2019
While we have not seen a confirmed breakout above the 1590 level yet, what are some potential catalysts that could push the Russell 2000 above this resistance? One could be the strength we have seen in Financials lately, which are the largest Sector (by weighting) in the index:
Second Small Cap thought:
If $XLF is breaking out, and has been a headwind for $IWM $RUT because it's the largest weighed Sector (at 17.6%), could Financials now be a tailwind for Small Caps if they can continue going higher? Hmm.
— Ian McMillan, CMT (@the_chart_life) April 28, 2019
FUNDSTRAT: "after a two month consolidation, a move by the Russell 2000 above the Q1 highs near 1602 would be a positive technical event and likely signal a rotation toward more cyclical groups, notably Financials."
— Carl Quintanilla (@carlquintanilla) April 30, 2019
And what about recent strength in the US Dollar ($DXY)?
In a note by John Murphy on StockCharts last week, he reminds us that a rising dollar is typically a positive for Small Cap stocks:
In fact, according to a piece put out by Perritt Capital…
“During periods of dollar increases of 15% or more, small-caps, as represented by the Russell 2000 Index, has achieved an annual total return of 13.2% versus 10.3% for the S&P 500, which represents large-cap stocks. On the flip side, when the dollar was weak, Small-Cap stocks compounded at 9.5% compared to the S&P 500’s return of 11.1%. In the chart below, you can see the historical relationship between the dollar and small-cap returns starting in the 1970s.”
And from a macro perspective, their findings make sense:
“In our opinion, small-caps are more levered to the domestic economy than larger companies are. Small companies are more likely to sell products domestically, insulating them from the loss of competitiveness and currency translation impact of a stronger dollar. When the dollar is strong, multi-national corporations lose a competitive advantage, as foreign buyers see U.S. goods as more expensive than non-U.S. goods.”
So, while we wait to see what direction the Russell 2000 takes over the coming days and weeks, we know that the index has one (and potentially two) gusts of wind at its back: Strength in Financials ($XLF) and a rising US Dollar. In addition, strength relative to the broad market may be turning around as well. On an absolute basis, the index has been consolidating for two months. Given that we can typically expect a trend to continue in the same direction, following a period of sideways price action, this is another piece of “ammo” that Small-Caps have on their side.