This part of the stock market is massively underperforming and should be a benchmark for investors
While the S&P 500 and the Dow Jones Industrial Average have continued to hit new highs seemingly daily this summer, the Russell 2000 Small Cap Index has agreed with the dance completely.
After peaking in March, Renaissance Macro Research strategists note that the Russell 2000 Index is now at its lowest relative since the start of the year against the S&P 500. Over the past six months, the Index Russell 2000 – which is made up of smaller US-focused companies – is up just 1.9%. The S&P 500 and Dow Jones rallied 15% and 10%, respectively.
“The divergence is noticeable, and we are starting to see bearish interval signals developing,” said Jeff deGraaf, RenMac strategist.
Under the hood of the Russell 2000, the trends are perhaps even more alarming.
Only 62% of Russell 2000 issues are trading above their 200-day moving average, RenMac notes. About 27% of small-cap pharmaceutical and biotech stocks – which tend to dominate the Russell 2000 – are above their 200-day moving averages.
The relative underperformance of the Russell 2000 Index could be seen as a red flag for bulls in the market.
Indeed, the message from small caps may be that US economic growth is set to slow until the end of the year amid the spread of the COVID-19 Delta variant and high inflation. While these macroeconomic effects would initially hurt the earnings of small firms the most, the earnings of the larger firms that make up the S&P 500 would hardly be immune (and by extension, neither would potential investors).
For now, RenMac’s deGraaf thinks it’s safe to extend Russell’s disappointing posture. But the index deserves more attention from investors going forward.
“We will have to see further internal deterioration and a break below absolute support before we turn downright bearish on the index. We also see an opportunity for trading long large cap versus short small cap pairs,” said deGraaf.
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