SMALL CAP LEADERSHIP -- RUSSELL 2000 IS EXPECTED TO BREAK THROUGH LAST YEAR'S HIGH

RUSSELL 2000 REACHES NEW HIGH... Our earlier update showed the small-cap Russell 2000 moving up to a new recovery high this morning. I take that as a positive sign for the market. That's because leadership by small cap stocks is the historical norm when an economy is recovering from a recession. The rising relative strength along the bottom of Chart 1 shows the small-cap index leading the large-cap S&P 500 since last year. Small cap stocks also play a big role in market breadth figures. That's because there's a lot more smaller stocks than larger ones. The weekly chart of the Russell 2000, however, shows that it's now retesting two previous peaks hit in the spring of 2002 and the spring of 2001. That's an important test for the Russell and the rest of the market. The big question is whether this is a topping pattern or just a pause in an ongoing uptrend. In my view, odds favor the latter. I think an upside breakout is the more logical outcome. Take a look at Chart 2.

Chart 1

RUSSELL 2000 MONTHLY CHART LOOKS MORE BULLISH... The monthly bars for the Russell 2000 paint a more bullish picture. For one thing, the major down trendline has been broken, which suggests that the bear trend has ended. The Bollinger Bands are also encouraging. Prices can normally be expected to reach the upper band, which currently sits at 544 (well over last year's high). In addition, the bands are expanding. That's usually a sign that the current trend is accelerating. [Contracting bands usually signal the end of a move]. Since the Russell 2000 has been a market leader all year, an upside breakout would be good for the rest of the market.

Chart 2