Small-cap rotation

●Russell 2000 pulled back to its August breakout level yesterday

●Last week the Russell was the weakest US major index

●Russell has tended to perform well after “off” weeks in recent months


When the Russell 2000 (RUT) pulled back yesterday, it marked the third time in the past seven days the small-cap index has retreated to the approximate level of its August 21 breakout, when it pushed decisively above the resistance of its June and July swing highs, on its way to a series of new records:

Russell 2000 (RUT), 5/21/18–9/17/18. Russell 2000 (RUT) price chart. Testing the breakout.

Source: OptionsHouse

Some bulls are likely not ecstatic that the RUT has been hanging around this breakout level rather than rallying decisively after the first time it tested it on September 7, and there may be another factor they’re taking into consideration—namely, the fact that the RUT was the US market’s worst-performing major index last week.

But that doesn’t necessarily mean they expect the RUT to break down.

Although the Russell lagged the broad market in late 2017 and in the first weeks of 2018, it’s trailed only the Nasdaq 100 (NDX) since then, and it’s the only US index besides the tech-heavy NDX to sport a double-digit return this year (around +11% as of yesterday). It’s been the best-performing index in 11 weeks since February—again, trailing only the NDX’s 14 weeks in the top spot.

Traders who watch the relative strength of the different US indexes and sectors from week to week (which you can do here every Monday) may have noticed a pattern over the past several months: When the RUT underperformed one week, it tended to outperform the next. That doesn’t mean when it was down one week it was up the next, or vice-versa; it means when the RUT had found itself at the bottom of the four-index heap that also includes the S&P 500 (SPX), Dow Jones Industrial Average (DJIA), and NDX, it had usually flipped to the upper half of the rankings the following week.

Last week the RUT lagged the field, returning 0.5%—around a third of the NDX’s 1.55% gain, and less than half the SPX’s 1.16% increase. Since February, the RUT has been at the bottom of the weekly index ranking four other times (the chart below marks the Fridays of those weeks); the following week it was the top-performing index twice, the second-strongest once and the third-strongest once. But more telling was the fact that its return for each of those weeks was positive, and the average for all of them was 1.39%—around six times the RUT’s average return for all weeks since February 2.

Russell 2000 (RUT), 4/11/18–9/17/18. Russell 2000 (RUT) price chart. Weeks RUT lagged the market.

Source: OptionsHouse

Yeah, we know, that’s only a handful of examples, but also consider the opposite scenario: For the 11 weeks following the times the RUT was the strongest index (since February), the index’s average return was only 0.09%, and five of those weeks were losers.

Of course, being the strongest index in any given week can simply mean losing less than the others, as was the case for the week ending February 9, when the RUT fell more than 4% but nonetheless shed less blood than its index compatriots.

If the entire market goes into sell mode, that’s always a possibility. But in the event it doesn’t, watching for index rotation may be one way to focus on areas of the market that could outperform in the near term.

Market Mover Update: Allstate (ALL) followed through yesterday on the rebound noted in “Florence puts insurance stocks in play”, putting up another daily gain (on a down day for the broad market) and bringing its total rally from last Tuesday’s low to almost 5%.


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