By Mark Hulbert
How worrisome is the performance gap between the S&P 500 and the Russell 2000?
The Russell 2000 Index RUT has gone almost four years without hitting a new high. This benchmark for the small- and midcap sectors of the U.S. market peaked on Nov. 8, 2021. Now, two years into a bull market that has taken the larger-cap S&P 500 SPX to successive new highs, the Russell 2000 is about 8.0% below its all-time high from three-and-a-half years ago.
According to Ed Clissold, chief U.S. strategist at Ned Davis Research, the Russell’s inability to surpass its November 2021 high represents “the longest streak on record while the S&P 500 was hitting records.”
The reason some believe this is worrisome is the belief that a healthy market is one firing on all cylinders. Divergences between the small- and large-caps are therefore seen as early warning signs of trouble.
Perhaps the most successful illustration of this came in the months leading to the top of the bull market in 2007. The Russell 2000 hit its bull-market high on July 13 of that year, and was more than 12% lower three months later when the S&P 500 hit its all-time high on Oct. 9. The Global Financial Crisis ensued over the next 16 months, and in retrospect many wish they had paid attention to that divergence.
Only short-term divergences are worrisome
The reason that the nearly-four-year divergence between the S&P 500 and Russell 2000 isn’t even more worrisome than 2007’s is that long-term divergences have little market-timing significance. That’s according to Hayes Martin, president of MarketExtremes.com, who has closely studied the conditions that accompany major market turning points. “From my work” Martin wrote in an email, “I find very long-term (e.g. multi-year) divergences to have little value in identifying major tops. What matters is the degree of diverging over a period of 1-3 months.”
Consider the Russell 2000’s all-time high in November 2021. When the S&P 500 hit its bull-market high two months later, the Russell 2000 was 7% lower than its all-time high. That divergence foreshadowed the 2022 bear market, in which the S&P 500 shed more than a quarter of its value in 10 months’ time.
The situation today is more favorable. That’s because the Russell 2000 over the past three months has been every bit as strong as the S&P 500 – gaining 18.7% versus 18.2% for the S&P 500. And, as my colleague Isabel Wang reported earlier this week, the Russell 2000 is approaching its first “golden cross” in 18 months.
For this and other reasons, Martin says “there is no evidence at this time of a major top.”
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com
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-Mark Hulbert
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