A second consecutive day of tight ranges seen in the major US stock indices with the exception of the small-cap Russell 2000 (more on it later) as the S&P 500 and Dow Jones Industrial Average flirted near their all-time highs level printed earlier in early May with less that 2% away from these levels at 4,238 and 35,091 respectively.
The Russell 2000 outperformed with a gain of +1.06% to close at 2,343; 0.7% away from its all-time of 2,360 printed on 15 March. Interestingly, its outperformance has started to surface on 25 May where it recorded an accumulate return of 6.26% till yesterday’s closing level versus a meagre gain of +0.93% seen on the S&P 500 over a similar period.
The main reasons for the recent stellar performance of Russell 2000 can be attributed to two attributions; firstly the upcoming annual rebalancing of this component stocks by its index complier FTSE Russell with preliminary updates releases on 11 and 19 June and the final changes on its component stocks will take effect on 28 June. Secondly, the resurgence of meme stocks in the past week where the share price of AMC Entertainment that has a significant weightage in the Russell 2000 surged by + 127% on a single session from 1 June to hit a fresh record all-time of 72.62 on 2 June triggered by another bout of potential short squeezes.
Positive momentum feeds further positive momentum at this juncture for the Russell 2000. The golden question in all traders’ mind will be can this current bull-run continue for the small caps? In order for the rally to be sustainable and translate into another potential major multi-month uptrend phase, the additional US$ 4 trillion fiscal stimulus package from the US White House must start to gain traction in bipartisan support in order to speed up the approval process in Congress. This modus operandi may reinforce the positive feedback loop on the on-going reflationary/economy re-opening theme play.
The next key factor to note will be US central bank, Fed’s guidance on its monetary policy. A significant portion of the component stocks in the Russell 2000 have high debt levels and face the risk of financial leverage if the Fed starts to taper its quantitative easing programme as it weighs on the negative impact from the recent heighted inflationary pressures versus the current accommodative monetary policy stance. A reduction on its current pace of bond buying (quantitative easing) programme to combat the future negative economic repercussions from a sticky high inflationary environment may trigger a liquidity squeeze and increase the cost of capital for small cap stocks. Hence, these two factors are likely to determine the direction bias of Russell 2000 in the coming months after June.