Russell 2000 continues to show relative strength

The Russell 2000 appeared to break out Friday and that has continued today, despite a darker tone for broader markets. The Nasdaq is down 1.2%, and the S&P 500 down 0.6% but the Russell 2000 is up 0.6%. That comes after a more-than 2% gain on Friday to the best levels since September.

There are two reasons behind the sudden outperformance:

1) Falling bond yields

Whereas the Magnificent Seven stocks could rally despite higher rates (due to low levels of debt), the broader market struggles with borrowing costs. The dramatic recent fall in yields has opened the window to a return to pre-2020 style markets with low growth and low inflation. That’s a much better setup for smaller caps than high, sticky inflation and a high Fed funds rate.

2) Broadening equity rally

There’s a broadening out of the equity rally in the US and globally. The S&P 500 is near the highs of the year while the Russell 2000 still has a long way to go. Similarly we’re seeing outperformance in beaten-up European equities and emerging markets.

With the broader tone in equities improving greatly in November, investors are looking for value and for stocks that haven’t moved. Some of the worst performers this year were indebted small caps; with the market sensing a peak in Fed funds and yields, those traders are storming back.

Technically, the chart is painting the same picture. There’s an inverted head-and-shoulders pattern that points to further gains up to 1926, which was also the August high. That might be a good stop for a break but for now, the signals are strong. It’s not often that you see such strong outperformance that shakes off the kind of backdrop we’ve had today.

Perhaps that’s where we take a break around the 15th or 20th of the month as tax loss selling hits. But in the latter half of the month, that will be exhausted and we could see a true Santa Claus rally that extends into mid-January and gets everyone all bulled up before the usual rug pull at that time of year.

This article was written by Adam Button at Source