So far, markets look to be tracking reasonably well the roadmap I’ve highlighted in the past: the previous weeks’ action is part of the temporary zig-zag I expect to continue into early Q3. Weekly technical indicators, which track 1-2 quarter shifts, should return to neutral to oversold territory, setting the stage for another multi-month upside move in equities later this year. Overall, the bigger picture pattern looks very similar to what developed in Q2-Q3 2016 and is the reason I remain optimistic for 2H19.

Small-caps action, however, has been notably sluggish and uninspiring, causing some clients to pushback on my outlook. However, I’ve seen markets transition from worry back to optimism over many cycles and it always feels and looks very uncertain in the late stages of a multi-week correction, about where we are today. Always.

So, let’s take a closer look at the Russell 2000 chart below of weekly data to identify technical levels that will help signal an improving technical backdrop.

1) Momentum – The top panel, a weekly momentum indicator, was overbought and peaking in late Q1, one reason I cautioned Q2 was likely to be more volatile. While still negative, I’m expecting this indicator to bottom and turn up by early to mid Q3. The Russell needs to rally just over 4% to turn that momentum indicator positive and thereby signal a new upside move underway.

2) Price – The current price pullback continues to look very similar to what developed in Q2/Q3 2016 shortly after the cycle low in Q1 2016. The Russell 2000’s price today is pulling back after a strong Q1 rebound from what I believe was another cycle low in December 2018. Given an uptrend is defined by higher highs and higher lows, a move back above the Q2 highs at 1618, just over 5%, is needed to confirm the index has resumed its uptrend.

Russell 2000 Index

Be Patient, Hold Your Fire and Keep the Powder Dry

3) Relative performance versus the S&P 500 – This is where my bullish view is less convincing given the relative performance trend has been down since the middle of 2018 AND is challenging levels last seen near the 2016 lows. Interestingly, this downtrend looks similar to what I see for many banks, which isn’t surprising, as the small-cap index is heavily weighted in financials and other cyclicals. It’s important to note, though, that it would not take much small-cap index rally to reverse that relative downtrend. What could cause that? I expect an oversold rebound in bond yields will likely be the catalyst in Q3.

Be Patient, Hold Your Fire and Keep the Powder Dry

Bottom line: Stay patient and keep the powder dry into Q3. The markets need to consolidate further into Q3 before I expect to see a more definitive technical improvement develop.

Be Patient, Hold Your Fire and Keep the Powder Dry
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