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Small-caps Weakening Near-term?

The Russell 2000 Index ETF (IWM) has struggled over the past couple of months as many market indexes have recorded all-time highs. After achieving a new high (159.38) during mid-Mar 2021, IWM remains shy of its record-high territory. Despite the recent weakness, the Small-cap market continues to outperform SPX for the year, rising 21.04% to the benchmark index's 10.09% year-to-date.


Is there a problem with the small-cap markets?


Like the Growth and Technology corrections during Feb-Mar 2021, inflation fears, and rising interest rates can be pressuring Small-caps, at least from a near-to-medium term perspective. Unlike the large-caps, the small-caps may not have the pricing power to pass on the higher input costs to consumers as inflationary pressures build. The squeezing of their margins may explain the recent underperformance between the small-cap stocks lagging their larger-cap counterparts. However, if the current inflationary pressure is transient, as per FED Chairman Powell, can Small-cap resume its primary uptrend?


On a technical basis, the intermediate-to-longer term trends in IWM remain decisively bullish. However, on a near-term basis, a head and shoulders top pattern is developing over the past few months. The head is 234.09 (3/15/21 record high), the left/right shoulders are 226-230 (Feb and Apr 2021 highs), and neckline support is 204.5-210 (late-Jan 2021 and Mar 2021 lows). The height of the pattern is 29.63 points. Violation of 204.5-210, coupled with a breakdown below its 38.2% retracement (202.21) from Oct 2020 to Mar 2021 rally) warns of a decline toward 190.5-192.5 (50% retracement and the late-Dec 2020 and Jan 2021 lows). Below this, suggests the next decline to crucial intermediate-term support coinciding with the head/shoulders top breakdown target of 175-180, the pivotal 200-day ma (184), and the 61.8% retracement (182.5) from the Oct 2020-Mar 2021 rally.


Since the dominant trend remains up, the recent setback may be a consolidation to alleviate an overbought condition before the resumption of the prevailing uptrend. Key initial resistance corresponds to 223-227 (50-day ma and Apr 2021 highs – right shoulders) and 227-230 (Fed 2021 highs – left shoulders). The ability to surge above this resistance zone signals an IWM recovery to 234.09 (3/15/21 all-time high – head). Above its record high of 234.09 confirms the resumption of the primary uptrend and suggests +29.63-points rendering an IWM technical to 264.


In summary, rising inflation and interest rates may be affecting the small-caps as represented by a potential head and shoulders top pattern in the Russell 2000 Index ETF (IWM). However, since the dominant and prevailing trend remains bullish, the recent pullback may also be a consolidation phase to alleviate an overbought condition before the resumption of the primary uptrend. From a technical perspective, a convincing move above 234.09 or the Mar 2021 high confirms the resumption of the primary uptrend. Below neckline support at 204.5-210 and 202.21 or the 38.2% retracement from the Oct 2020-Mar 2021 rally confirms a head and shoulders top and warns of a deeper IWM correction.


Source: Courtesy of StockCharts.com

Source: Courtesy of StockCharts.com

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