There’s a whiff of panic in the air. Since small-cap stock benchmark Russell 2000 turned 1000 a month ago it has slipped into consolidation along with the broader market. Though the index is only off 6% (hitting its corrective low-point today) from its peak May 22, this decline is almost twice the deepest pullback year-to-date and it comes in a post-FOMC, presumably pre-QE “taper” environment where cash (and volatility products such as VXX, though that never ends well) seems to be the sole safe haven.
I won’t attempt to give assurances that this pullback can’t devolve into an ugly correction. The Fed has signaled their policy is about to enter a new regime, ending 5 years of unmitigated accommodation. For the first time in what seems forever, markets were reminded in the only voice that matters (Ben Bernanke’s) that they will one day be called on to again go it alone. The first lights of a dawning post-QE era are tempering the monochromatic monetary horizon we’ve all become numbly accustomed to: but the market (and the Fed, if Bernanke is taken at his word) is confused about whether morning is near, or a new night is around the corner.
Stocks, among other markets, have been considering all of this since Bernanke and other Fed Governors began dropping more transparent hints about “tapering” with the FOMC meeting April 30-May 1. Pull up a chart and you’ll see the result of this deliberation is a 4-week long bull flag in which price has oscillated up and down in a creeping downward pattern. The latest oscillation down on the Russell (beginning with release of the latest FOMC statement Wednesday at 2 p.m. ET) has been swift and merciless: -5% in 2 days.
With that decline, the Russell 2000 is tiptoeing on the edge of incurring some major technical damage – for the first time since the mid-November bottom. The index may be on the brink of a deep hole, but at this moment – though I seem to be one of the few – I’m not yet convinced it’s going over.
Here’s a few thoughts on why (click image to zoom) :
It’s easy to dismiss a mature trend like the one under way since November when a visceral, semi-panicked sell-off like this one occurs. The FOMC meeting was scheduled, Bernanke’s “tapering” remarks well-telegraphed over the previous month, but the selling still came; and it came fast, hard and evidently with some leaning much too heavily to the long side.
But the trend is still intact; and I doubt once the equities market stands back and digests the past few days it will decide to let 950 on the Russell 2000 go so easily.
What would it take to change my mind?  Everything on the chart above being negated. A clean break of 950 – which means a break of rising channel (white) and bull flag (blue) supporting trend lines. A clean break of the 100-Day SMA (which held up so well under repeated attempts to snap it in April) at 945. It also means working off the deeply oversold state the Russell 2000 currently finds itself in – a state that has proven bouncy (see matching blue rectangles on top and bottom chart panels), even after bouts of cascading multi-day distribution (see early/mid-April). Also, look left: how quickly we forget 895-950 was a long, hard-fought range that will act as a major volatility and momentum-limiting buffer if R2k attempts to cross it.
Stocks may seem “due” for a bona-fide correction – November-May had a breezy complacency that sloughed off the fiscal cliff, sequester and Cyprus with an alacrity that was more sugar high than abiding confidence. And the consensus that Bernanke is about to reduce the market’s narcotic consumption has never been received (see Summer 2010, Summer 2011 for what happens) well.
These kinds of observations seem valid; but they just aren’t the “stuff’ discrete, risk-defined trade theses are built around. Acknowledge stocks are on the edge – and have a contingency plan if they decide to jump – but until the technical features mentioned above are behind us, continue to look onward and upward as the trend still suggests.
Twitter: @andrewunknown and @seeitmarket
Author holds long position in Russell 2000 mini futures (Symbol: TF) mentioned at the time of publication.
Any opinions expressed herein are solely those of the author, and do not in any way represent the views or opinions of any other person or entity.
