Small capitalization stocks are often cited to have a leading tell to them as it relates to the broader U.S. stock market’s future direction. While I would offer that it is rarely wise to use any one ‘indicator’ alone, I do think given the current juncture we have arrived at in U.S. equities, that small caps should be watched with a close eye.
For perspective, let us remember that the Russell 2000, from here forward represented by the iShares Russell 2000 Fund (IWM) staged a major breakout past a multi-year resistance line in January of this year. The break past the $86 area ultimately allowed the index to gain further upside momentum that lasts to this present day. The index’s rally off the October 2011 lows was vicious but continually allowed for backing and filling to work off the overbought levels at any given time. The move higher since November 2012 however is extremely steep and likely long in the tooth. It is merely a question of time before the Russell 2000 corrects more than a few percent. Thus, from this longer-term perspective I am cautious on small caps, and for that matter on the broader market.
It is crucial to note that my above musings on the longer-term state of the Russell 2000 however do not preclude any further upside potential in the near-term.
Last Thursday’s sharp intraday upside turnaround, followed by confirmation buying on Friday and Monday snuggles the IWM right up at a new mini-resistance downtrend line from the May highs, but also puts upside momentum back into play. A break above Monday’s highs of $98.80 could lead to a re-test of marginal break of the May all-time highs. At the same time, last week’s low on Thursday gives bulls and bears alike a new support level to focus around near $95.70 – a break below which would clearly be bearish.