Russell 2000 Breaks Out to All Time High With a 15-Day Winning Streak

by the Curmudgeon

Overview:

The Curmudgeon has been especially perplexed and bewildered by the Russell 2000 Index of 1989 small cap stocks (ETF symbol IWM).

We stated in our most recent post that the Russell 2000 was up 15 consecutive trading days through last Friday, November 25^th, with a gain of 16.5% during that time. It was the index’s best-ever performance in winning streaks that stretched 15 days or longer, according to Bespoke Investment Group. The last 15-day winning streak for the small cap index was over 20 years ago – it ended on Feb. 6, 1996. But there was only a 6.1% gain, which was about 1/3 that of the recent up move in the index.

In recent blog posts, I’ve stated what no one else has talked or written about: that the Russell 2000 52-week trailing P/E = “nil” (source: WSJ) or “N/A” (source: Yahoo Finance). That’s because the composite earnings of the 1989 companies in the index was negligible, zero or negative (we don’t know which).

Trailing P/E=nil arguably demonstrates that the stock market is NOT a discounting mechanism! Here’s why: One year ago, forward earnings estimate for the Russell 2000 was 20 vs. a then trailing P/E of 146. In other words, the market was expecting much better earnings for the small cap index, but the actual earnings were much worse than they were in the previous year (when the trailing P/E was a sky high 146). Despite have no earnings, the Russell 2000 index has rallied strongly since February 11^theven though the earnings forecast was dead wrong!

The Russell 2000’s breakout advance is clearly depicted in the charts below, courtesy of Dow Theory Letters.

The zoomed-in chart on the right side (above) shows the remarkable 15-day winning streak that propelled the index to new all-time highs. It ended on Monday November 28^th and the index was down very slightly today (November 29^th).

Dow Theory Letters Perspective on the Russell 2000:

Matthew Kerkhoff of Dow Theory Letters (subscription required) wrote yesterday:

The Russell 2000 has been rallying for a variety of reasons, mostly tied to Trump’s economic plan. If regulations are relaxed, taxes are lowered and money is dumped into infrastructure projects, the small caps stand to benefit more than their larger brethren. These small cap firms are better positioned to benefit from stimulus spending, and often pay a higher effective tax rate than multinational companies. The strong weighting towards financial and bank stocks has also helped the Russell 2000 rally as financial stocks have been a pocket of strength.

Does that bullish forecast negate that collectively, the companies in the index have no earnings? Or since the market supposedly also looks 12 months out, should you pay attention to the forward P/E estimate of 19.55 from Birinyi Associates via WSJ’s Market and Data Center?

What’s Next?

The late Paul Montgomery of Legg Mason said that consecutive closing streaks in stocks or stock indexes, much like gaps, were not randomly distributed. They occur either at the start, direct mid-point or the end of a market move. The Russell 2000 has been rallying since Feb 11^th, so its 15 consecutive-closing higher streak is not the start of a new move as so many pundits have labeled it.

Looking at the aforementioned 1996 winning streak, the small cap index ran up another 2.5% to a record close one month after the streak was snapped, and another 8.2% three months after the streak ended. A year later, the Russell 2000 was up 15%.

A week after the four prior winning streaks of 15 days or more since 1979 (the record was 19 trading days in 1985) the Russell 2000 was up 1%, on average. A month later it was up 2.4% and higher all four times. After a small consolidation three months out, which saw gains of just 0.9%, the Russell 2000 was up solidly six months later, with average gains of 6.3%.

Regarding favorable seasonality next month, Jeff Hirsch of Almanac Trader wrote:

Over the most recent 21-year period, December has developed a pattern of opening with strength lasting until about the third day for DJIA, S&P 500 and Russell 1000 (NASDAQ and Russell 2000 tend to run a bit higher into the sixth or seventh trading day) before moving sideways and finally lower into mid-month giving back any gains and then some by the eleventh trading day. From there, the major indices generally consolidate until the fourteenth or fifteenth trading day before rallying to close out December.

Conclusions:

Stock market history suggests that long streaks of price gains tend to keep going. That’s true even if the gains are based on unrealistic expectations. There are also bullish confirmations among the other main stock market indexes and no technical negatives. However, it is very late in this 7.75-year bull market, valuations are extremely high, the post-election advance is fueled by expectations of economic growth and profits that may not be realized. Extreme caution is advised in establishing or adding to US equity positions.

Good luck and till next time...

The Curmudgeon
ajwdct@sbumail.com

Follow the Curmudgeon on Twitter @ajwdct247

Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies. Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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