What’s in Store for the Russell 2000

If the majority of your cash is held in large-cap stocks, you probably are somewhat envious of small-cap investors at this time. The blue-chip DOW is down 1.30% so far this year, and this is following a poor 3.15% gain in 2004. The year 2003 was much better for the DOW, up 25.32%, but it still underperformed.

 As I discussed in a previous column, large-cap stocks are not absent of risk. Just take a look at the large-cap market over the past few years. In a rising market, especially after the economic slowdown we went through, you want to invest in small companies. Small companies are able to adapt faster to changes, compared to their mid- and large-cap counterparts. We have seen this over the past few years during the bull market, and I expect this trend to continue going forward.

 The reality is that buying continues to be focused on the small- cap and tech front. On the small-cap side, the Russell 2000 is leading the key market indices, up 5.16% on the year and at a historical high. Trading at 685, the index is on the verge of taking out 700 for the first time.

 If you base the upcoming performance on the current uptrend, the Russell 2000 will probably end this year ahead of the other major indices, confirming that small-caps tend to outperform. The barometer of small-cap performance led the pack in 2004, gaining 17%. And in 2003, the Russell 2000 surged 45.37%, trailing only the tech-laden NASDAQ’s return of 50.01%.

 On the charts, since showing a bullish double bottom in 2002, the Russell 2000 has been on steroids, as the major upward trend remains intact.

 The chart shows that the current trendline will drive the Russell 2000 towards 700. The near-term technical picture is firmly bullish. But, given the buying, the index is extremely overbought, so we could see some near-term selling pressure as the index trends higher. This is normal and, in fact, healthy in a bull market. But, in the event we see some selling pressure, downside support levels are found at the 20-day moving average (MA) of 670, followed by the 50-day and 200-day MA of 645 and 623, respectively. You want to watch if the index can hold at these support levels. For instance, should the 20-day MA break below the 50-day and 200-day MA, it would be bearish.

 So, unless we see a major reversal, I expect the index to trend higher. Once the 700-point resistance level is breached, the next upper target would be around 740. If this is attainable by year- end, it would represent a 13.57% gain for the Russell 2000, lower than the last two years, but much better than we can expect from the other indices in this climate.