Russell 2000 is Flashing Warning Signs

Russell 2000 is flashing warning signs, reports Lynn Thomasson at Bloomberg:

The Russell 2000 Index’s record one-month gain is sending danger signals to investors who remember how similar rallies in U.S. stocks came to an end.

The gauge of companies with a median value of $301 million is beating the Standard & Poor’s 500 Index, where stocks have an average market value of $6.5 billion, by 9.8 percentage points. Gains in the Russell 2000 are being led by an 11-fold jump in Spansion Inc., a bankrupt chipmaker, and a sevenfold rise for Hayes Lemmerz International Inc., a wheel manufacturer that hasn’t had a profit since 2006.

While small-caps tend to lead the way out of bear markets, when they have outpaced larger stocks by this much, both indexes erased gains and fell, according to data compiled by Birinyi Associates Inc. Increased trading and ratios of advancing to falling stocks have also risen to levels that preceded declines, boosting investor concerns that the S&P 500’s 27 percent advance since March 9 will end the same way as the 24 percent rally that fizzled in January.

“This move is too explosive to be sustainable,” said Jack Ablin, chief investment officer at Chicago-based Harris Private Bank, which oversees $60 billion. “None of the structural underpinnings of the market have really changed. It’s going to be a multiyear healing process.”

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Steeper jumps for small-cap stocks one month into a rally are signs of indiscriminate buying and usually come before equities fall, said Cleve Rueckert, a Birinyi analyst. The Russell 2000’s 36 percent climb since March 9 is its steepest since the index began in 1979, according to Bloomberg data.

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“It’s unusual for a new cycle to start with such an abrupt gain,” Rueckert said. “Bear market rallies are broad. Everything goes up really sharp, really fast and not necessarily for a particular reason.”

None of the bull markets tracked by Birinyi included small- caps outperforming after a month by the rate they are now. On average, smaller stocks are tied with the S&P 500 at this stage of a lasting recovery, the data show.