Small-cap stocks, along with their primary index the , have struggled since the COVID pandemic began in 2020. on the Russell 2000 Index – which appeared to be benefiting from reflation trading late last year, the US Federal Reserve turned on its path to rate hikes, signaling the first hikes would come in 2022, and small caps took a hit again. ]
Of the four major US indices, the , , and Russell 2000, only the small cap index has entered bear market territory. That happened when the benchmark fell by 20.94% between the record November 8 and the closing price on January 27.
As a frame of reference, the second worst performing was . The tech-heavy index fell 15.1% from its record January 4 to the end of January 27; the SPX fell just 9.8% over a similar time frame, between the January 3 record and January 27 low, not even entering the correction zone, which starts at -10.00%. Finally, as a result of the above measures, the mega-cap Dow outperformed, retreating only 7.24% between the record January 4 and the end of January 27.
The Russell 2000 is lagging behind for several reasons: small caps are sensitive to rising labor costs and escalating . They also lack the accounting flexibility available to the multinational megacaps listed on the Dow Jones. In addition, their position as domestic companies that are not known worldwide makes them more vulnerable to the economic cycle.
So, is JPMorgan Chase strategist Marko Kolanovic's recent positive call for knocked-down small caps, which he considers a buy, right?
We don't think so. First, the 20% drop from the all-time record small cap index has set in a bear market is likely to worsen sentiment on the Russell 2000. In addition, the index's technical data points to an ongoing decline.
The Russell 2000 has formed a rising wedge, bearish after its first plunge. The placement of the pattern suggests that the bullish channel will be broken as the index's slump accelerates.
Last month the 50 DMA dropped below the 200 DMA, leading to a Death Cross. Since then, the 100 DMA has also fallen below the 200 DMA, sending the three primary MAs into a bearish pattern.
This happened as the benchmark fell slightly out of its bullish channel after the small cap index broke below its bullish trendline for the first time since the March 2020 bottom.
The rising wedge would require a downward breakout to start the downward chain reaction. Otherwise, the price could still retest the descending channel top, which coincides with the previous slightly ascending range. complete the wedge or for the price to retest the top of the bearish channel with resistance followed by a failed rally.
Average traders would be satisfied with either a return to the top of the wedge's channel or a breakout at the bottom.
Aggressive traders can now go short, provided they are willing to accept the risk of a wedge failure and a return to the top of the channel. Money management is key. These are the basic requirements for a coherent trading plan:
Trading example – Aggressive short position
Input: 2.045
Stop Loss: 2.055
Risk: 10 points
Target: 1.945
Reward: 100 points
Risk Reward Ratio: 1:10
