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Breakout Watch: The Russell Rages Higher

Investors are spending the dog days of summer spinning bearish yarns as they wait for the market to show its hand.

A quick trip into the bowels of finance Twitter will land you smack in the middle of endless debates about whether Elon Musk will go to prison for his “funding secured” declaration or how low bitcoin might drop during its latest selloff. Folks are even arguing over when exactly the current bull market started — and when it might vaporize into a harrowing crash.

But it’s tough getting too bearish after witnessing yesterday’s market action.

Turnaround Tuesday was in full effect yesterday as the major averages pushed higher to finish the day in the green. The S&P 500 fought higher to take back Monday’s losses, while the Nasdaq Composite maintained its leadership role.

Digging below the big earnings movers, there’s more bullish action shaping up under the sensational headlines.

You might not have noticed that the small-cap Russell 2000 index is once again creeping back toward the top of its summer trading range. The Russell’s gain of more than 1% during Tuesday trade handily outpaced the major averages for the day. The move also hints at a big breakout that could set the stage for a massive fall rally…

Small cap

We’ve tracked this small-cap “coil” since the Russell posted a higher low in late July. Now these small stocks just need a little nudge to get over the hump.

How did we get here? Here’s a quick recap:

Following a powerful spring rally, small stocks overheated in June. After failing to top 1,700 following multiple attempts, the Russell rolled over in late July as tech stocks and other momentum names weakened. While everyone was watching Facebook shares tank, the small-cap index dropped almost 2% in single day in late July to close near its one-month lows.

The Russell bounced back in the weeks that followed. But there’s little doubt that much of the momentum that pushed the index to new all-time highs over the summer had evaporated. The summer trading doldrums left much of the stock market stuck in neutral in early August. Small stocks followed suit.

This is normal behavior for smaller stocks following a big rally. Ever since the 2016 election, the Russell has tended to trade in short, powerful moves higher, followed by periods of consolidation. We’ve been in one of these periods nearly all summer.

Following the spring small-cap rally, I expected these names to retreat, search for support, and generally trade in a choppy range. After all, even the biggest winners need to blow off steam every once and a while. Small stocks have enjoyed a strong year. But they’re not immune to the forces of supply and demand. Now after a few months of sideways action, they’re setting up for a potentially explosive end-of-year rally.

The Russell’s outperformance so far this week also shows us that investors are still willing to pile into riskier assets — a move that’s bullish for the entire market.  If small-caps break out to new highs over the next few weeks, we can assume the major averages will follow suit.

Sincerely,

Greg Guenthner

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Greg Guenthner, CMT, is the editor of Rude Awakening PRO and Seven Figure Signals. He has been with Agora Financial/Seven Figure Publishing for 13 years. In 2018, Greg’s Rude Awakening PRO portfolio beat the S&P 500 by 14%.

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