Commentary: The Russell 2000 could be pointing the way higher

At a time when markets are in complete retreat it seems strange to suggest it, writes IG analyst Christopher Beauchamp, but perhaps the Russell 2000 is sending a signal that the worst may be coming to an end.

The small cap index was the first to suffer sharp drops this year, back in February, but its sell-off from September heralded the beginning of the widespread volatility (i.e. losses) that global markets have been enduring over the past months.

The Russell 2000 has underperformed throughout 2014, whereas the S&P 500 is still (at pixel time) in positive territory, and the Dow is down 2.6%, the small cap index has fallen by 7.8%.

However, mindful of Warren Buffett’s dictum to be ‘greedy when others are fearful’, the time may have come to look afresh at the Russell 2000.

A ratio of the Russell 2000 to the S&P 500 presents us with an interesting situation. The chart can be seen above.

The ratio is now at its lowest point in around five years. When the ratio falls to such lows it can present an impressive buying opportunity for small caps.

The 2009 low on the above chart came in late November 2009. By mid-February the index had gained 13%, and following an early-year correction the index went on to record further gains until mid-May.

Gains from the ratio’s lows in September 2011 and July 2012 also saw gains for the Russell 2000.

At the end of February this ratio was at elevated levels and the result was not pretty for the Russell 2000.

Now, it looks as if the worst may be over, and where small caps lead, the bigger boys tend to follow.