Russell Index Analysis: IJE vs. RUI and RUT, Technical, Divergence and Correlation Analysis (Part 3)

This post was originally on the Dvolatility Research blog on 6/29/2014.

Current Trends Look Similar to 2007-2008

First, it seems like we are just repeating 2007 and early 2008 again when inflation was rising, geopolitical tension was rising in the middle east, oil kept making new highs, and the Fed was tightening (the Fed sold Treasuries (pulled liquidity) towards the end of 2007 (see below), which coincided with the top in the market). Now it seems like ending QE is a form of tightening, and it's supposed to end in October.

Source: Liberty Street Economics (The SOMA Portfolio Through Time)

IJE, RUI and RUT Divergences

After covering RVX/VIX, RUT/SPX and RUI/RUT (large-caps/small-caps) on my first two posts, I now want to add micro-caps to the mix, specifically the Russell Microcap Index (IJE). Unfortunately IJE only goes back to 2005, but it will do for now. Before I get into the ratios, look at the massive divergence between the Russell 1000 and Russell MicroCap Index in the chart below. To me, this is just more evidence that the stock market is slowly being invaded by bears and nervous bulls. It looks like RUT and IJE pulled back to match, or come close to matching RUI's one-year performance, but I think this move means that market participants are starting to avoid lower quality stocks.


IJE/RUI's Correlation With RUI

This chart of IJE/RUI (Russell Microcap Index/Russell Largecap Index) versus RUI and its correlation is also flashing a warning signal for the market. IJE/RUI's 3-month correlation with RUI made two new cycle lows in 2014, which were last seen between mid-2006 and early-2007 right before RUI put in a monthly double top.


IJE/RUT, IJE/RUI Technical Analysis Since 2005

IJE/RUI has been riding on a pretty strong uptrend since 2009, but it's still way below its 2006 high. If there's a real market correction in the next few months (large-caps actually fall), I think IJE will plunge again relative to RUI, which would put IJE/RUI's uptrend line at risk.


It's interesting that IJE significantly underperformed RUT between 2006 and 2012, well into the current bull market. (This could be more evidence that RUT is significantly overbought and overvalued here). The ratio broke out in 2012, but the relief rally ended in tears in early 2014. After IJE/RUT bounces, I think it will test its 2012-2013 uptrend line, but I'm not sure where it will be in the next 1-2 years because of RUT's move. (I think the RSI and PPO look bearish for the ratio. The top indicator is the RSI.)


IJE Technical Analysis Since 2009

On IJE's chart, 69-70 is a very important support level on the chart because it is where the bull market's uptrend line hits today and the next few months. As noted on the chart, if it breaks through that level, I think it will bounce around in that red triangle and eventually test 2011-2012 support (around 54).

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