Strange and Concerning Pattern on the Russell 2000

Rick_PendergraftLast week, I was exchanging emails with our publisher about the Russell 2000. He had asked me if I saw a certain pattern in the chart, but I didn’t really see what he was asking about. The RUT has been in the news with a number of sources pointing out the “death-cross” the index just set up. A death cross occurs when the 50-day moving average crosses bearishly below the 200-day moving average.

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Looking at previous instances when this happened on the RUT chart, I didn’t see any real statistical advantage to going short the index. It was pretty much a 50-50 indicator where the index gained ground in about half the instances and lost ground in about half. Don’t get me wrong, there are some indices, stocks and commodities where a death-cross is a great indication of what to expect for the next few months.

While I didn’t see the head and shoulders pattern our publisher was looking at and I didn’t see an advantage to the bearish crossover of the moving averages, there was something in the chart that did catch my eye. I have never read of a pattern such as this, but I am going to call it a mirror. If you look at the vertical blue line, and consider the colored circles on each side of the line, you see that the events are playing out in the reverse order. Not only are the prices similar, but the timeframes are almost identical.

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Depending upon how long the pattern continues, this could be a bad sign for the RUT as the next major direction change would come down at the 1,010 area which it hit in August 2013. If the index drops down that far, we are looking at another 9.5% to the downside from the present level.

Overall, stocks have been on a heck of a run over the last two years, but as you can see from the chart, small cap stocks have stalled out in 2014 and have essentially moved sideways all year. If you look at the year to date performances of the Dow, S&P, Nasdaq and Russell, you see how the larger cap indices have outperformed.

Index YTD Return
Nasdaq 7.88%
S&P 7.00%
Dow 2.98%
Russell -3.93%

If you look back at the first three quarters of 2007, the performance of the RUT was similar in that it had bounced back and forth from negative to positive for the year while the other three indices outpaced it. I think we can all agree that we don’t want a repeat of the market environment that started in the fourth quarter of 2007 and lasted through the first quarter of 2009.

The way the RUT has lagged the other three indices could be part of the rotation I have talked about in this space before. Rather than just rotating from one sector to another, perhaps investors are rotating away from small cap and into large cap stocks. If that is the case, it still shows investors are moving toward a more cautious stance.

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