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Robert McHugh

Robert McHugh

Robert McHugh Ph.D. is President and CEO of Main Line Investors, Inc., a registered investment advisor in the Commonwealth of Pennsylvania.

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Are Small Caps Topping?

Small cap stocks, as represented by the Russell 2000, have had a nice run up. However, there is compelling pattern evidence this weekend that suggests they are topping and a significant decline is fast approaching. We have three charts that suggest this forecast.

First, we show a chart that compares price movement with a plotting of its 10-day average Advance/Decline Line Indicator. When prices rise for an extended period of time, and while that is occurring, the A/D indicator is declining, this is a Bearish divergence, telling us fewer and fewer stocks are participating in the advance, warning a top is approaching and a reversal lower is around the corner.

RUT 10-Day Advance/Decline Line versus Russell 2000

Next we show a mapping chart with Elliott Wave notations, that shows the Russell 2000 is completing an Expanding Ascending Wedge, which is a topping pattern. This is a large degree pattern, has been ongoing for two decades, and is now coming to an end. This is a Weekly Chart and it shows the Full Stochastics are overbought.

Russell 2000 Weekly Chart

Interestingly, at the tail end of this large degree pattern is another pattern that is a topping pattern of smaller degree, a Megaphone pattern, that looks complete, or very nearly so. The next chart gives us a close up view of this pattern.

The troublesome aspect of this chart is that it gives an approximate downside price target, which is the bottom declining boundary line, in this case around 700. This suggests it is possible a 50 percent decline in small caps is possible. That is hard to believe, but this is typically a reliable pattern. Now crashes are rare, so we won't be betting the farm on this pattern, but it sure is cause for caution at this time.

 


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