Much of the financial media is almost exclusively focused on large-cap indices like the S&P 500, which technically thus far has avoided bear market territory. However, the picture for the small-cap Russell 2000 — as represented by the iShares Russell 2000 Index (ETF) (NYSEARCA:IWM) — is much uglier and arguably more reflective of the current economic environment.
A very straightforward and bearish pattern on the IWM ETF continues to play out. In fact, another 20% drop could be in the cards.
During a meeting with a large investor yesterday in midtown Manhattan, an analyst made his bull case for U.S. stocks, which focused on his hopes of further earnings multiple expansion and the fact that the S&P 500 is merely flat for the year (because it has bounced back strongly).
As I told the analyst, while there are always two sides to a coin, if we look away from just the S&P 500 chart and over to things like corporate profits, economic data and broader U.S. indices … well, things look gnarlier.
The fact is that corporate top and bottom lines continued to decline year-over-year, and that U.S. economic data, while “holding up,” is showing the same trajectory.
That brings me to the charts of the Russell 2000 and the IWM, which as an index much more closely represents the U.S. economy given that most of the sales of index components takes place within the United States.
IWM Charts
On the multiyear weekly chart, we see that after the IWM broke out of its multiyear holding pattern in 2013 and rallied into 2014, it began building a notable head-and-shoulders pattern as marked by the blue triangles. Another rally attempt in the first half of 2015 shaped the head of this formation, and as stocks fell off a cliff in January, the IWM snapped the neckline (black horizontal) of this formation.
In fairly classic fashion, the Russell 2000 then rallied back sharply and marginally back above this neckline as bears got too greedy for the intermediate term. If this pattern wants to continue playing out, the IWM should soon resume the downward trajectory.
On the daily chart, we see that the red 200-day simple moving average has acted as a decent area of support and resistance over the past couple of years, and that on a weekly closing basis, this moving average also held as resistance in April when a move above it was quickly met by selling.
The way we can now measure an ultimate downside target for the IWM ETF is by taking the difference between the highs in June 2015 and the black horizontal and subtracting this difference from the neckline, as illustrated by the blue arrows.
If economic gravity and the reality of the business cycle will continue to play out, coupled with the bearish picture on the charts, the Russell 2000 should see another significant drop from here.
Specifically, a measured move would get the IWM into the high $80s over the next few months.
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