At the time of writing, European stocks followed US stocks higher after yesterday's Wall Street session revealed that reflation trading is alive and well and that all four major indices have recovered.
What seems to have been overlooked in all bull market rumpus are value stocks – companies whose profits suffered during the lockdowns caused by the COVID-19 pandemic, when growth stocks in the tech and communications sectors in particular fared better . The recent story indicated that now that economic growth is back on track, value stocks would rise.
Indeed, Bloomberg predicted from yesterday the industry's revenue growth for 2021 in the future. In their model (visible here), value stocks are expected to increase sales by as much as a third in the first quarter, while growth stocks sales are expected to decline by a fifth year on year.
That outlook is buoyed by strong earnings results from Europe, most recently from Swiss food and beverage giant Nestle (SIX :), which said "organic sales should grow more than expected this year," citing strong growth in the first quarter for its coffee and dairy products divisions. The increase was fueled by additional delivery services to consumers stuck at home during pandemic lockdowns, as well as restaurants stocking up in preparation for reopening as lockdown restrictions in the US and parts of Europe begin to lift.
That would mean that the outlook for a wider range of small and domestic companies listed on the stock exchange should be brighter as they profit from the reflation trade. In fact, analysts think this earnings season could be the catalyst for flying the small cap index. But the technical factors for the Russell are the weakest of the major US benchmarks. The small cap index moved sideways even as peer indices posted record after record.
Small caps form an H&S top, complete with a down-cut neckline, connecting the lows of the range.
Meanwhile, the RSI, which measures momentum, has created a powerful negative divergence, first when momentum hit a ceiling, while prices continued to rise from November, then, when the RSI dropped outright, against the price increase between February and February. March, for both highs and lows.
The RSI continues to struggle, now between the November support and its declining channel. If it breaks support, it would be another signal that investors are cashing in on their small caps.
However, keep in mind that the price will only be complete after a decisive breakout, which should also include the converging upward trend line.
Trading Strategies
Conservative traders must wait for the price to fall below the cartridge neckline and upward trend since the low of 2020.
Moderate traders would go short after the completion of the H&S, even without the price falling below the upward trend.
Aggressive traders could go short at will, provided they accept the higher risk corresponding to the higher reward of beating the market in case the pattern never completes. A higher risk means a greater need for a careful trading plan. If you don't know how to set one up, here's a simple example:
Trade Sample
Entry level: 2,250
Stop-loss: 2,300
Risk: 50 points
Target: 2,000
Reward: 250 points
Risk: Reward Ratio: 1: 5
Author's Note: We cannot predict the future. We can give our interpretation of the balance between supply and demand and likely statistical results. Even if we are right, this is just an example. There are several ways to approach this trading, and you need to know how to adapt a trading plan to suit your timing, budget, and temperament. Until you learn how to do that, you can follow our guidelines, to learn, not to make a profit, or you won't get either.
