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Market update

Russell 2000 catching up with Dow: Relative Rotation Graphs

The Relative Rotation Graph (RRG) below shows the rotations of major world stock indices, using the MSCI world index as a benchmark. The big picture is broadly similar to last week, with most markets in the leading quadrant, offsetting the underperformance of US markets.

However, there are signs that the picture is beginning to change slightly, with several of the tails in the leading quadrant rolling over and changing direction, indicating that they are losing relative momentum. In contrast, US markets – which had been travelling in a south-westerly direction – are beginning to turn upwards.

Thus, the main takeaway from this chart is that non-US markets remain in a relative uptrend compared to US markets, but that story could change in the near term. Time will tell whether signs of an imminent shift in the narrative are temporary or continue to play out.

Non-US markets losing momentum

When we zoom in on the daily RRG for 30 June, it is clear that non-US markets are dipping, signifying that they are losing relative momentum.

The two tails that caught my eye on the chart above are those of the Russell 2000 (RTY) and the Dow Jones (INDU). These two tails are rotating in opposite directions, with RTY moving up and INDU trending down. As regular readers of my commentary will know, these sorts of pairs can highlight potential opportunities that may form part of an overall trading strategy.

The interesting thing is that the Russell 2000 is a broad-based index, containing – as its name suggests – 2000 stocks, while the Dow Jones Industrial Average is narrow, made up of 30 prestigious, large-cap companies. 

The key takeaway here, then, is that in the near term the broader Russell 2000 could catch up with – and potentially overtake – the more prominent Dow Jones. 

Is the Russell 2000 on the cusp of an upturn?

The Russell 2000 price chart, below, shows that the index peaked towards the end of 2021 and then trended downwards in a series of lower highs and lower lows. It’s still in that process.

But if you look at the seven-day relative strength index (RSI) at the bottom of the chart, you will notice that the most recent low does not quite tally with the previous low in the price chart, causing a mild positive divergence. The RRG lines in the middle section of the chart are still below the 100-level, but they have bottomed out and are now moving upwards, giving us an early indication of what may be to come.

Dow down deeper and down

The Dow Jones Industrial Average also peaked at the end of 2021 before beginning its descent. That downwards trend remains the status quo for now. The big difference here is that the Russell 2000 dipped to a lesser extent and recovered more easily, while the Dow is having trouble getting back above its breakout level.

While the Russell 2000 chart showed both RRG lines moving up after a decline, the above Dow Jones price chart indicates that the RRG lines are rolling over and starting to move lower. 

Although the price charts for the Russell 2000 and Dow Jones appear similar at first glance, there are some significant differences when you get under the bonnet. Closer analysis suggests that the outlook is improving for the Russell 2000 vis-à-vis the Dow, at least heading into next week and possibly beyond. 

US dollar remains strong

Changing tack, let’s take a look at major currencies. The weekly RRG below shows the ongoing strength of the US dollar against the world’s other G10 currencies.  

Meanwhile, the daily RRG for 1 July, below, shows that most tails are rotating upwards, heading towards and into the improving quadrant, which is shaded blue. However, given the rotations on the above weekly RRG and the predominantly vertical moves on the daily chart below, it looks as though the recovery may be temporary. The various currencies shown in both charts are improving only in terms of momentum. They are not yet improving in terms of relative strength.

Has the euro bottomed out?

Focusing on the monthly EUR/USD chart below, we note that for the second time in a matter of weeks the market has tested support at the 1.03 area. If we look back at 2000 and the late 1990s we can see why the 1.03 level is so important.

The 1.03 area has provided support during a few major market turnarounds, most recently in 2015 and 2017. This means that a break below 1.03 could open up further downside potential and pave the way for much more USD strength. That said, we should remain open to the possibility that EUR/USD could establish some sort of bottom formation, respect the 1.03 support area and start a new rally from there. We should soon get a sense of which development is more likely.

Pricing is indicative. Past performance is not a reliable indicator of future results.

RRG’s views and findings are their own and should not be relied upon as the basis of a trading or investment decision.

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