When liquidity levels dry up, the first sectors to get hit are comprised of high beta stocks. Of course the NASDAQ and stocks like Tesla (TSLA), Facebook (FB), and Priceline (PCLN) come to mind first, but the small cap market, the Russell 2000, is largely regarded as the highest Beta major market on the Street.
Not surprisingly, the small cap market has been hit hard as stimulus cuts reduced excess liquidity in our economy, and that is not likely to change. In our outlook for 2014 (Issued in December of 2013), Stock Traders Daily suggested that Investors avoid the Russell 2000 because of the exodus of stimulus, and the action in the ETF that follows the Russell 2000 (IWM) substantiates that call.
IWM fell from the longer term resistance level in our report to the longer term support level, and it is now threatening to break below longer term support as that is defined in our trading report for IWM. A breakdown from here would be very bad for the Russell 2000, but even if a breakdown does not happen immediately, it certainly seems likely to happen at sometime relatively soon.
According to our macroeconomic work, net real stimulus in the United States came to an end on April 1, and soon the combined efforts of the US Treasury and FOMC will have a net drain on domestic liquidity levels for the first time in years. This is critically important to high beta stocks like those in the NASDAQ and the Russell 2000, but those are also only usually the first to get hit.
Eventually, after the lower excess liquidity levels impact higher beta names, the rotation to the larger and traditionally perceived as more conservative stocks occurs. The Street tends to discount rapid decline like what we have seen in the NASDAQ and Russell 2000 until such time as the Dow and S&P 500 start to get hit, but the progression outlined in our Outlook for 2014 suggests that this will happen; it is just a matter of time.
Our macroeconomic work suggests that the growth rate in the US economy was fabricated by stimulus dollars as well, and stimulus is over, so there could easily also be an overshoot on the downside as this corrects itself and the natural state of the economy resurfaces again. Our recommendation to avoid the Russell 2000 stands.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: By Thomas Kee for Stock Traders Daily and neither receives compensation from the publicly traded companies listed herein for writing this article.