IS THE RUSSELL 2000 WAGGING THE RUSSELL 1000? -- TRANSPORTS AND AIRLINES CONTINUE SHOWING RELATIVE STRENGTH -- JETBLUE RECOVERS AFTER SUPPORT BREAK -- UNITED FIRMS AFTER SHARP DECLINE -- SHORT-TERM YIELDS DIVERGE FROM LONG-TERM YIELDS
IS THE RUSSELL 2000 WAGGING THE RUSSELL 1000?... Link for today's video. There has been a lot of talk about relative weakness in the Russell 2000 and small-caps over the last few weeks. While relative weakness in small-caps is a concern, we should not read too much into this weakness without first understanding the nature of the Russell 2000. First, let's consider the make up of the index. The Russell 3000 accounts for 98% of investable equities in the US and this index can be divided into the Russell 2000 and Russell 1000. The Russell 2000 represents the smallest two thousand stocks in the Russell 3000. Conversely, the Russell 1000 covers the one thousand largest stocks in the Russell 3000. The Russell 2000 represents small-caps, while the Russell 1000 represents large-caps. Apple, ExxonMobil, Microsoft, J&J, GE, Chevron, Wells Fargo, Berkshire Hathaway, Procter & Gamble and JP Morgan account for around 15% of the Russell 1000. Here's where it gets interesting. The Russell 1000 accounts for some 92% of the Russell 3000. This means the Russell 2000 accounts for just 8% of the Russell 3000 and less than 8% of the total market capitalization of all US listed stocks. This would seem to make the Russell 2000 the tail and the Russell 1000 the dog. Further more, betting on the Russell 2000 taking down the Russell 1000 seems to suggest that the tail is wagging the dog.
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Chart 1
Unsurprisingly, studies show that the Russell 2000 is more volatile than the Russell 1000. Chart 1 shows the Russell 2000 and the Russell 1000 with the zigzag indicator set at 10%. The red arrows mark declines that were more than 10%. I am only focused on the declines within the uptrends from 2003 to 2007 and from 2009 to the present. From the 2003 low to the 2007 high, the Russell 2000 declined 10 percent or more six times and the Russell 1000 declined 10% or more just once. From 2009 until now, the Russell 2000 shows eight such pullbacks and the Russell 1000 shows just four. Clearly, the Russell 2000 is more volatile and more prone to 10+ percent pullbacks than the Russell 1000. Chart 2 shows the Russell 1000 challenging the March-May highs with a move toward 1060 this week. While these highs may offer resistance, this index is by no means weak because it is less than 1% from recording a new high.
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Chart 2
TRANSPORTS AND AIRLINES CONTINUE SHOWING RELATIVE STRENGTH ... The Transport iShares (IYT) and the DJ US Airline Index ($DJUSAR) hit new highs this month and remain two of the strongest groups in the stock market right now. Chart 3 shows IYT within a steady uptrend the last eight months. The October trend line and late April high combine to mark support in the 135 area. The indicator window shows the price relative (IYT:SPY ratio) hitting a new high this month as the Transports iShares outperforms the overall market. Chart 4 shows the DJ US Airline Index in a clear uptrend and hitting a new high last week. The indicator window shows the price relative ($DJUSAR:$SPX ratio) in an uptrend as well.
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Chart 3
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Chart 4
JETBLUE RECOVERS AFTER SUPPORT BREAK ... Delta (DAL), Alaska (ALK) and Southwest (LUV) are the strongest airlines because they recorded new highs this month. American (AAL) is trading near its early March high and close to a new high. My eyes, however, are on a pair of laggards that may play a little catch up. Chart 5 shows Jetblue (JBLU) breaking out with a surge from early September to late November. The stock then embarked on a long consolidation and broke support with high volume in late April. This support break did not hold as the stock surged back above 8.5 with even better volume. Looks like a bear trap. Upside volume on the rebound was strong enough to push OBV to a new high. If volume leads price, as Joe Granville theorized, then JBLU is headed for a breakout and new high in the coming weeks and months.
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Chart 5
UNITED FIRMS AFTER SHARP DECLINE... United Continental (UAL) is also a laggard, but the stock is finding support near the 50% retracement line and the December consolidation (green zone). As with Jetblue, I think the long-term trend on this chart is up. Using this assumption, the decline is considered a correction and I am expecting the long-term uptrend to resume at some point. UAL fell sharply with a move below 40 in late April and then firmed. Most of the May price action has been above 40 as the stock consolidates. A break above the consolidation highs would be positive and provide the first indication that the bigger uptrend is resuming. The indicator window shows Aroon Up and Aroon Down falling below 30 with a parallel decline. The parallel decline means a consolidation is underway on the price chart. Both moving below 30 means there is no real upside or downside direction. The first Aroon to turn up and break above 50 will provide the next directional clue. Note that UAL is breaking out as I write and Aroon Up is surging.
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Chart 6
SHORT-TERM YIELDS DIVERGE FROM LONG-TERM YIELDS... There is an interesting dynamic underway in the Treasury bond market. Long-term rates fell to their lows of the year (2014), but short-term rates are still on the rise and may ultimately prevail. In fact, we may be near an important inflection point for Treasury yields and Treasury bonds. Chart 7 shows four different treasury yields in the main window. I duplicated the 2-year Treasury Yield ($UST2Y) in the first indicator window to highlight fluctuations. The 10-YR Treasury Yield ($TNX) and the 30-YR Treasury Yield ($TYX) fell this year and are both below their February lows. The 30-YR Treasury Yield is even below its October low. Meanwhile, the 5-year Treasury Yield ($FVX) and the 2-year Treasury Yield remain above their February and October lows. Even though the 5-year and 2-year yields are down year-to-date, they are still in uptrends over the last six to seven months and have yet to break down. Perhaps the economy is not as weak as the long end of the curve would have us believe. This may also explain why the S&P 500 and large-caps are holding up quite well.
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Chart 7
SHORT-TERM YIELDS ARE POSITIVELY CORRELATED WITH STOCKS... Chart 8 shows monthly bars for the 2-year Treasury Yield ($UST2Y) over the last ten years. I am using a log scale to highlight the magnitude of the change from the 2007 high to the 2011 low and analyze the last two years. First, notice that the yield formed a higher low in the spring of 2013 and broke out later that summer. Second, notice that a triangle formed the last six months and this could be a consolidation within an uptrend. A breakout would argue for higher yields and target a move to the 1% area. Even though this suggests a doubling of the yield, 1% is still well below the 2007 peak and low by historical standards. In other words, it is just one more step on the road to normalization.
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Chart 8
The indicator window shows the 12-month Correlation Coefficient ($SPX,$UST2Y) spending around 90% of its time in positive territory. The indicator was in negative territory for a maximum of 12 months, which means it spent the other 108 months in positive territory. Correlations are subject to change, but the overall correlation here is clearly more positive than negative. This suggests that a breakout in the 2-year yield would be bullish for stocks. This also indicates that a failure to breakout and a move below triangle support would be bearish for stocks. Chart 9 shows the 5-year Treasury Yield ($FVX) breaking above 1.5% last year and consolidating the last six months.
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Chart 9
TREND IN JOBLESS CLAIMS POINTS TO HIGHER RATES... Jobless Claims could well influence the overall direction of short-term rates and the stock market. At this point, we are well past the flash crash in May 2010 and the European debt crisis of 2011. While there could be another "event", the markets are currently normalizing and this means interest rates should further normalize as long as this trend continues. Chart 10 shows Initial Jobless Claims ($$UNEMPCIN) in a clear downtrend over the last five years. Claims dipped below 300,000 twice this year and the four-week average is below 325,000. In fact, claims are at their lowest level since 2007, but Treasury yields are nowhere near their 2007 levels. Further declines in Initial Claims would put upward pressure on Treasury yields and this would be bullish for stocks. A break above 355,000 in the four week average would reverse this downtrend in Jobless Claims.
