US Sector Forecast – The Russell Breaks Out and is Poised to Continue to Rise

The Russell 2000, (US2000) a small-cap stock index, broke out to new all-time highs and is likely to continue to trend higher. Momentum has turned positive, but prices are overbought. The strength in the dollar is changing the asset allocation mix, to domestic stocks from international. As US yields rise, Russell 2000 is experiencing gains in all of its smaller regional banking companies. Historically the returns for the Russell 2000 are mixed in February.

Strong Dollar Drives Russell

The Russell 2000 broke out and gained traction as the dollar rises and US domestic stocks accelerate higher. There appears to be a change in asset allocations out of large-cap international stocks and small-cap domestic shares. Additionally, as US yields rise and the yield curve steepens, all of the regional banking companies listed as part of the Russell 200 are outperforming. If US yields continue to trend higher and the dollar gains traction, the Russell should continue to outperform.

Seasonality

Historically, the Russell 2000 has mixed results in February. During the past 10-years, the Russell 2000 has increased in value 70% of the time for an average gain of 1.2%. During the last 5-years, the returns were not as promising. During this period, the Russell 200 index (US2000) declined 60% of the time for an average loss of 1.2%.

Technical Analysis

The US2000 broke out on Monday and rallying sharply during the prior week. The US2000 rallied 8.25% during the first week of February and followed those gains up with a 1.8% rally on Monday. Support on the US2000 is seen near the 10-day moving average at 2,155. Target resistance is seen near the slope of the highs near 2,300.

Prices are overbought. The fast stochastics has surged higher, reflecting accelerating positive momentum. The current reading on the fast stochastic is 97, well above the overbought trigger level of 80, which could foreshadow a correction. The relative strength index (RSI), which is also a momentum index, surged higher, reflecting accelerating positive momentum. The current reading on the RSI is 74, above the overbought trigger level of 70, which also could foreshadow a correction. During the last runup in the US2000, the RSI hit 78 before correcting.

Medium-term momentum has turned positive as the MACD (moving average convergence divergence) index generated a crossover buy signal. This occurs as the MACD line (the 12-day moving average minus the 26-day moving average) crosses above the MACD signal line (the 9-day moving average of the MACD line). The MACD histogram also generated a crossover buy signal by slicing through the zero-index line. The MACD histogram is printing in positive territory with an upward sloping trajectory, which points to higher prices.

The Bottom Line

The strength in the US dollar and US yields helps drive capital flows into the Russell 2000. Momentum is strong and rising, which should help the index trend higher. Prices are overbought and could face a temporary consolidation period as traders take profit. Look to dollar cost average lower, looking for the trend to consolidate and then spring higher.