This Puzzling Breakout is Back on Track…

It’s been one of the most difficult breakouts we’ve tracked this year.

Yet despite all the waiting and false starts, small-cap stocks are once again ripping higher.

So we have to ask: Are we finally witnessing the signs of an epic small-cap comeback?

For the second time in less than four months, small stocks have taken the express elevator from the basement to penthouse.

Back in June, it took just three days for the small-cap Russell 2000 to move from the brink of a breakdown to less than 1% from its all-time highs. By July, the small stock index was pushing to never-before seen levels. At the time, it looked like we were in for one hell of a run…

But the party didn’t last. All it took was a little broad market weakness to send small stocks crashing back down to earth. After topping out in late July, the Russell 2000 tripped and fell nearly 7% in just three weeks. It was a terrifying drop for small-cap investors. A false breakout followed by a quick collapse kicked the Russell below its 200-day moving average for the first time in more than a year.

But the Russell’s near-breakdown was enough to shake out most of the weak hands. The brief trip below its 200-day moving average didn’t slow small-caps for long. In fact, they’re back to doing what they do best: beating the pants off the S&P 500.

The Russell 2000 has jumped more than 6% since it bottomed out on August 21st. Meanwhile, the S&P 500 has squeezed out a gain of about 3.4%. Any investor hanging onto small-caps this summer was forced to endure an insane, get-wrenching round-trip.

The market action we’ve witnessed proves just how choppy small-cap stocks have been since the unprecedented post-election rally.

To be fair, the November small stock rally was just as shocking as Trump winning the White House. As of early December, the small-cap Russell 2000 had jumped 40% above its February lows thanks in part to an incredible 14-day run to cap off November trading. It was the index’s longest winning streak in more than 20 years.

At the time, I told you the action is exactly how big changes in trend happen. One second, everyone hates small-caps. Just when the last seller leaves the building, a monster rally begins to take shape.

But the small-cap rally moved too far, too fast. Here’s an updated version of the chart I showed you back at the close of the second quarter:

Small-caps followed up their furious November rally with more than nine months of range-bound action (the false breakout back in July couldn’t officially bust open the wide trading range).

Now signs are pointing to another round of higher prices.

At the very beginning of the year, I told you every shred of evidence I have collected is pointing to an extended surge in smaller stocks. Even though we haven’t seen any strong follow-through after the November surge, the choppy, sideways action in the Russell hasn’t swayed our longer-term thesis.

Sincerely,

Greg Guenthner
for The Daily Reckoning

The Daily Reckoning