Russell 2000 ETF Rally Could Lead Equities Higher

by: Tom Lydon

Smaller companies have typically led the charge at the beginning of any recovery, and with small-capitalization stocks and exchange traded funds hitting new highs, market observers are anticipating bullish, broad market moves.

The iShares Russell 2000 (NYSEARCA:IWM) has gained 10.0% over the past three months and is up 20.7% year-to-date.

"It's bullish that the Russell 2000 has reversed its downtrend off the May 22 highs and breaking out to new highs," Craig Johnson, technical market strategist and managing director at Piper Jaffray, said in a CNBC article. "And when we get an index as broad as the Russell 2000 breaking out to new highs, that suggests that the internals of the market is very strong and we have a lot of stocks that are participating in this move."

The Russell 2000 finished above 1,000 for the first time last Friday and is now trading around 1,017. So far this year, the Russell 2000 has outperformed the S&P 500, gaining 20% compared to the S&P 500′s 16%.

Market experts consider the outperformance a bullish indicator for the overall market since small-caps are believed to be a good gauge for the domestic economy.

Moreover, the rising interest rate has not made been holding back the equities rally - the Russell 2000 has gained 8.3% as the benchmark 10-year Treasury yield rose a full 1% since early May. The benchmark yield currently hovers around 2.65%.

With rising interest rates, investors are shifting away from dividend paying stocks toward riskier equities that could generate better capital gains.

"And right now, another reason you're seeing this massive small-cap outperformance is because with bond yields moving higher, [small caps] have become more competitive versus stocks that pay dividends," Todd Salamone, the director of research at Schaeffer's Investment Research. said in the article. "So you're seeing a rotation out of high-dividend stocks as investors seek higher returns via capital gains and higher beta type names such as the small cap."

iShares Russell 2000

Click to enlarge

Max Chen contributed to this article.

Full disclosure: Tom Lydon's clients own IWM.

Disclosure: I am long IWM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.