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Forget about the Mag 7. If there’s going to be a year-end rally in the stock market, it’s going to be led by the small-cap stocks.
The Russell 2000 Index – an index of 2000 small-cap stocks – has had a wild year so far. After bottoming in late-March, the index led the broad stock market higher for five months as it gained nearly 30% versus a 22% gain in the S&P 500.
For the past several weeks, though, the S&P 500 has been powering to new all-time highs while the Russell 2000 has fallen 9%.
It is this decline, however, that has set the stage for a rally into the end of the year.
Take a look at this chart of the iShares Russell 2000 ETF (IWM)…
The action over the past few weeks has created a bullish falling wedge pattern on the chart. Meanwhile, as IWM has been making a series of lower lows, the momentum indicators at the bottom of the chart have been rallying. This sort of “positive divergence” is often an early warning sign of an impending rally.
IWM closed Tuesday near the support line of the wedge. It’s also sitting right above the support line connecting the April and May lows. And, there’s additional support just below near $270.
All these factors should limit any potential downside in IWM from here.
At the same time, IWM is approaching the apex of the wedge pattern. It will likely break out, one way or the other, within the next several days. A break to the downside should quickly find support at the levels indicated – which should then lead to a bounce attempt.
A breakout to the upside, though, should lead to an immediate rally towards the 50-day moving average line above $290. And, if IWM can power able that level, there’s a good chance it will be headed to its all-time high near $305.
In other words, the current setup in IWM shows about $8 of downside risk while the upside offers a reward of as much as $28.
There’s no guarantee, of course. There never is in the financial markets. But, if the stock market is setting up for a year-end rally, and if the “rotation” action we’ve talked about previously is going to play out, then traders should be looking to buy into the small-cap sector on any weakness over the next few days.
Best regards and good trading,
Jeff Clark
Editor, Market Minute