Monday was a miserable day for the small cap Russell 2000 and it may get worse.
For the first time in over two
years, the Russell 2000’s 50-day moving average traded below its 200-day
moving average. Technical analysts call that move a “death cross,” and
it’s a very bearish signal.
Traders responded by showing
their bearishness on the index with options trades on the ETF that
tracks the Russell 2000 (trading under the symbol IWM). On Monday,
options on the IWM were the second-most active on the market, with three
out of four of them bearish put positions.
Since the current quarter began,
the Russell 2000 has fallen 5.3 percent while the large cap S&P 500
index has gained 1.7 percent. The Russell 2000 is now 7 percent below
its all-time highs and is the worst performing major market index in the
U.S. markets.
But just because the small caps’
prices now coming down, that doesn’t make them a bargain, according to
Gina Sanchez, founder of Chantico Global.
“They have been weak but their valuations are still high, which
fundamentally doesn’t make an argument for buying the Russell [2000]
right now,” said Sanchez, a CNBC contributor. “Given where we are in the
recovery, they should be stronger.”Instead, Sanchez sees several troubling signs, particularly with the number of Nasdaq Composite stocks trading in bear market territory. As of Monday afternoon, 1,202 out of the 2,559 stocks on the Nasdaq were trading 20 percent or more below their 52-week highs. Sanchez sees trouble for the Russell 2000 because the two indices share a lot of the same constituents.
“We’re looking at a lot of situations where stocks really aren’t as strong as they should be,” lamented Sanchez. “That’s a negative signal for the recovery and particularly for small cap stocks.”
Likewise, Richard Ross, global technical strategist at Auerbach Grayson, is also wary of the Russell 2000. “There’s a lot working against the Russell 2000,” said Ross, a “Talking Numbers” contributor. “This is made up of smaller stocks–largely U.S.-focused–not exposed to that stronger dollar. So the Russell [2000] should be working here, but it’s not.”
Though Ross is negative on the Russell 2000, his view is not based on the fact that it now trades below its 200-day moving average. “When markets become range-bound, moving averages like the 200 [day] lose their efficacy to a certain degree,” he said. “You want to use those moving averages in a trending market, which this is not.”
(Read: Julian Robertson sees TWO bubbles brewing)
While Ross sees no discernible trend over the past year, he is concerned with the index’s three-year chart. “Longer-term, we go from bad to worse,” he said. The Russell 2000 may have held its 150-week moving average and an upward-sloping trend line since 2011, but it recently made a bearish double top pattern.
“That’s a big warning sign,”
Ross said. “When you get a double top at the tail end of an 85 percent,
3½ year move, that’s telling you something. If we sneak below that trend
line and we take out that neckline of support around 1,082…you’ve got
big trouble here. There could be as much as 15 percent downside. You
want to be a seller of the Russell ahead of that downside.”
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