As Small-Caps Explode Higher, Trading Gets Tricky
Conditions are very overbought, but strong markets stay sticky to the upside as folks on the sidelines seek entries.
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The rotational action that investors have anticipated for years finally took hold after the consumer price index report last Thursday, but the move has been so big and so fast that it now presents a dilemma. According to Bespoke, the Russell 2000 is 4.4 standard deviations above its 50-day moving average, which is the most overbought any index has been in history. The Russell 2000 is up over 10% in just four trading sessions.
Typically, stocks with this much momentum do not suddenly collapse and go straight down. This sort of move creates a large supply of folks who missed the move and are sitting on the sidelines, hoping to put money to work on pullbacks. There is now a huge supply of dip-buyers, and they will likely be so anxious to buy that they will keep the pullbacks shallow.
The best thing that could happen at this point is that there is a pullback and some churning, which allow short-term traders to lock in gains and more patient longer-term investors to build new positions.
What makes it more interesting is that major second-quarter earnings are just starting to hit. Conditions are good for some sell-the-news action after some big jumps, but in many cases, smaller stocks are still substantially undervalued vis-à-vis big caps. We will see big-cap technology names report before the great bulk of small-caps, and that may help create better technical setups for another leg higher in the Russell 2000.
There is weakness on Wednesday morning in semiconductors and the Magnificent Seven names due to talk that the Biden Administration may impose tariffs on China. Biden has been floating a number of aggressive economic policies, such as price control on rent, as he tries to shore up his floundering campaign.
Bonds will be key as they have reflected growing confidence that the Fed will cut rates at its September meeting, but it wouldn’t be too surprising to see some doubts creep in as investors contemplate how stocks are reflecting a strong economy.
The good news is that the market may be due for some profit-taking and consolidation, but that will help create better charts and entry points.
At the time of publication, DePorre had no position in any security mentioned.
