A shot across the bow and the Russell 2000

The Russell 2000 has traded sideways in a 40-point range for seven weeks.

US trader
Source: Bloomberg

The Russell 2000 is a bell weather index of the US economy, and the best gauge of the market’s reflection on Trump’s policy. This index contains the smaller-listed companies that may not have overseas tax shelters or Cayman Island PO boxes. Some of the companies included are Bottomline Technologies (EPAY: an electronic payment services company), Hovnanian Enterprises (HOV: a home builder operating in 18 states in the US), and Nuvasive (NUVA: a medical device development company).

This index represents the grass roots industry of the US economy that will receive the most benefit from tax reform and the type of border protectionist government policy that President Trump is advocating.

Within the Russell 2000, there was an immediate reaction to the Presidential result in November up until the Federal Open Market Committee’s (FOMC) decision to raise rates on 12 December 2016. Since that date, the index has not closed at a higher high, which would immediately infer that interest rates matter even if they are at the lowest level in human history. Borrowing cheap money can look very expensive if the interest component of that loan moves 4% overnight. 

So while the world is consumed with the DOW at 20,000, the real world of business is evaluating the road ahead in an economy that now has a real inflation rate. The FOMC would be busy punching the numbers to make sure interest rates now commensurate with Trump’s economy.

As always, the truth is in the charts. The top right weekly view shows the seven weeks of sideways movement with a 50-point range following the initial rally from early November; this is a bullish flag pattern that has well over a 70% outcome to a top side breakout.

The top left chart is the daily and clearly shows the support level at 1340. Going forward, this will the key level to watch and the point of give up by the buyers, a close below this level would signal a breakdown and potential retest of the 1267 breakout level mid-November 2016.

Russell 2000
Click to enlarge

The bottom right chart is the four-hour timeframe showing a five-wave movement down with the fifth wave - the capitulation move, a move that shakes the confidence of the bulls (this is not an Elliott wave methodology). From a price action perspective, the bottom left one-hour chart really gives an indication of the market’s belief, as it shows the intersession move down and a very fast recovery at the support level later in the session.

This end of the market now has some very defined limits to the downside, a break of the 1340 level would push out the buyers and test stop loss levels set below this point.

The business end of the market is very much grappling with the forward look of Trump’s policies and company earnings in a rising interest rate environment. While we can never know what the future holds, keep in mind the sage advice from traders, “Never short a dull market”.

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