[Chart of The Week] A Small But Mighty Pattern In Small-Caps

JC Parets
July 24, 2019

From the desk of Tom Bruni @BruniCharting

JC and I are generally on the same page about a lot of things, but this week our brains seem to be very in sync as we're writing about the same topics with a slightly different spin on each subject.

Yesterday JC spoke about how US Equities can do just fine, actually really well, during periods of Small-Cap underperformance.

Today I want to take a more granular look at the Russell 2000 and see what its recent price action has in common with the Euro Stoxx 50.

It's clear the Russell 2000 has been a bit of a dog, consolidating below its May highs while many Large-Cap indices in the US are breaking out to new all-time highs. With that said, we've been in the camp that this consolidation in prices looks more like constructive action to work through overhead supply before continuing higher, not a major top.

If we look at the consolidation in the Euro Stoxx 50, which just resolved higher, and the one in the Russell 2000, they look almost identical. A tight, bull flag continuation pattern. Depending on what color glasses you have on you can either see this pattern as a lower high in the Russell 2000 (relative to May) or a consolidation period after a rally off of its June lows.

For me, I need to be in the second camp as long as prices are above their late June lows near 151. Prices have not broken down to confirm that this uptrend from the June lows is broken. If we break the last pivot low of 150.75, then we can talk. But for now, I don't see what everyone is so worked up about.

Click on chart to enlarge view.

Now I will admit there are two key differences between the two chart patterns. First, unlike Euro Stoxx the Russell is consolidating below recent highs and second, momentum has been unable to register an overbought reading since February (while Euro Stoxx 50 has hit overbought on four separate occasions since March).

Maybe that will matter, maybe it won't. But as Equity market bulls, we remain in the camp that rotation into weaker areas of the market like Small/Mid-Caps and Transports is underway and that new highs in these areas will be made.

What's going to drive this rotation into the smaller/mid-sized cap segments of the market? Sector rotation, which we're already seeing into Financials. If Regional Banks can catch a bid here and work their way higher, that would be a big tailwind for the Russell 2000, which has a nearly 16% weighting in Financials, as well as Health Care and Industrials which also have roughly the same weighting.

JC and others that have pointed to periods like 1995-1999 are right, Small-Caps do not have to outperform for the broader market to move higher. With that said, we would at least like to see prices trending higher with the rest of the Equity market on an absolute basis, even if they're underperforming.

A break out of this bull flag could be the start of its move back to all-time highs near 170...and if that's happening, we're probably in an environment where Equities aren't doing too badly.

Thanks for reading and let us know if you have any questions!

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Allstarcharts Team

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