Inside Markets — RTY Retest

The Russell 2000 (RTY) has outperformed large cap benchmarks (SPX and NDX) over the last three sessions and is higher today as the index tests the cycle high at 2264. In our opinion, a sustained close above 2264 and corresponding strength in copper prices would signal the beginning of a cyclical rally. We faded the July RTY break above multi-year pattern resistance at ~2140 because it was unconfirmed in cross markets, specifically copper. The same thing seems to be happening now with the RTY threatening a breakout, while copper lags on China growth concerns. Markets discount future events and nearly every cyclical recovery (US manufacturing ISM has been in contraction for nearly 2 years) has been preceded by outperformance in the RTY with copper trading higher in lockstep. There’s significant alpha generation at stake as the RTY has underperformed the SPX by 29 percentage points over the last two years.

The S&P 400 Mid Cap Index (MID) also tends to outperform prior to and during a cyclical recovery. There may be less alpha generation in the mid-cap stocks in the event of a cyclical recovery given 21 percentage points of underperformance over the last two years. But the forward multiple on the MID is far more reasonable at ~14x compared to the RTY and SPX at ~21x.