Last week the Dow broke through 22,000 to new all-time highs but the overall market has been developing a serious case of bad breadth, with gains concentrated in a small number of large cap stocks. Recent trading in the Russell 2000 indicates that not only are the troops no longer following the generals forward, small and mid-cap stocks have started to retreat. This week, the focus of earnings shifts toward smaller companies giving an opportunity for traders to see how the broader market responds to earnings reports and guidance.
The chart above shows that as the recent bull market has progressed, the more narrow NASDAQ 100 and Dow 30 indices have increasingly outperformed the broader S&P 500 and Russell 2000. This indicates that gains have been concentrated in fewer and fewer large cap stocks. The NASDAQ outperformance has been driven mainly by 5 big stocks: Facebook, Apple, Amazon, Netflix and Google. The recent Dow outperformance has been driven primarily by one stock; Boeing.
On the flip side, small cap stocks, which had lagged to the upside, have started to break lower. The Russell 2000 recently peaked near 1,450 and then broken under 1,430 causing an uptrend support line to fail. The index has since broken its 50-day average near 1,415 which has become new resistance.
Next potential support appears near the 1,400 round number. Should that fail, the next big downside technical test could appear at the 200-day average near 1,370.
The relative weakness of the broader Russell 2000 index appears to be suggesting growing concern about the health of the broader US economy. Broader indices featuring more domestically oriented companies may not capture the impact of the falling US Dollar in the same way that large cap indices could.
Earnings season usually starts out with the largest companies in each sector reporting first, then works is way down the ladder to small and mid-cap companies. Most of the S&P 500 has reported by now, but a ton of companies in the Russell 2000 may release results this week. In addition to seeing whether smaller companies are as successful in beating expectations as the big companies have been, we should get a better idea this week of whether traders are seeing positive reports as reason to add to long positions or an excuse to take profits.
Recent declines in the Russell 2000 suggest that overinflated expectations may be coming back to Earth, but with the Russell trading at 25.7x forward earnings still way above the Dow (17.5x), S&P (18.0X) and even the NASDAQ 100 (20.1x) either the street has been overly pessimistic about small and mid-cap earnings or the troops could be really vulnerable to disappointment.
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