Russell 2000 Relative Strength Going Too Far

The recent up move in the Russell 2000 Index has been amazing, and is worthy of comment.  It has far outperformed the Russell 1000 Index over the past few days, resulting in a strong move higher for the relative strength ratio in this week's chart.

This indicator moves upward when the Russell 2000 Index is outperforming its large cap brother on a relative basis.  Usually that means the Russell 2000 is moving up faster, although it can also happen by moving down more slowly.  Generally speaking, small cap outperformance is a bullish factor for the overall market.  It usually means that there is so much excess liquidity sloshing around that even the less deserving small cap issues can get some of it.  That is likely what it means now.

But it is possible for a good thing to go too far, and exhaust itself.  That is likely what has happened with this rush into the Russell 2000.  One trick I like to do with the relative strength line in the chart above is to measure how far it has moved from its 5% Trend (AKA a 39EMA).  That is what this next chart’s indicator depicts.

The blue line represents how far, in percentage terms, the relative strength ratio above has moved above or below its 5% Trend.  Usually a reading above +2% is good enough to mark a short term top for prices. This one is more than twice that amount.

It takes a lot of energy to make investors mount a rush into small caps like this, and it is possible for that rush to go too far and exhaust itself.  We saw a similar exhaustion event back in December 2023, and it led to an early January 2024 pullback.  That is the risk for the momentum chasers who are participating in this rush.