U.S. Markets closed

Forget the 'death cross', big money may buy into the Russell 2000

Lawrence Lewitinn
Talking Numbers

Things have been going great for the large-cap indexes but not so much for the Russell 2000, which has been suffering from a bearish “death cross.” However, are things about to change for the small-cap index?

On Wednesday, the S&P 500, the Dow Jones industrial average and the Nasdaq composite index all had their best day since Aug. 18. And while the Russell 2000 gained about 0.9 percent on the day, it is still the only major index down for the year.

(Watch: Stock rally halts 3-day rout for S&P 500, Nasdaq)

But according to one market expert, that may all change.

David Seaburg, head of equity sales trading at Cowen and Co., says the spread in performance between the S&P 500 and the Russell 2000 is too wide to last.  The S&P 500 is up 8 percent year to date, while the Russell 2000 is down 3 percent in 2014.

“It has been this high only four times in the past four years and each time it has gotten here, you’ve seen a close of the gap between performance,” said Seaburg of the spread between the two.

The underperforming Russell 2000 may see an influx of money managers looking to spruce up their portfolios by buying bargains, Seaburg said. “Toward year-end, you’re going to have this performance chase again,” he said. ”Fund managers who are underperforming the market are going to jump back in and start to buy some of these smaller-cap names that have really been pressed down.”

The technicals, though, disagree with Seaburg, said Richard Ross, global technical strategist at Auerbach Grayson. “There’s actually a litany of bearish evidence against the Russell right now,” he said. “We’ve got a lot of problems here and the ‘death cross’ is just one of them.”

The year-to-date chart shows the Russell 2000 has traded in a well-defined trading range between 1,082 and 1,212. Those two levels have each held twice this year as support and resistance, respectively.

(Read: 15 investments to avoid)

The longer-term chart, however, is more ominous to Ross, a “Talking Numbers” contributor. “This is a chart that should really scare you,” he said. “I would be a seller into year-end of the Russell.”

The Russell 2000 recently broke down below a trend line it had been above since 2011. Additionally, the 1,212 resistance level in the short-term chart has served as a bearish double top in the long-term chart. That double top’s support is at the short-term chart’s 1,082 support level.

“If we were to take out that neckline of 1,082—which the shorter-term technicals suggest we will—that could set the stage for a precipitous drop down to key support—hold on here—to 862,” said Ross. “That’s over 20 percent down from current levels. It can happen.”

The 862 level is significant for two reasons. First, it served as resistance from 2011 to 2012, according to Ross. Secondly, it is roughly a 61 percent retracement of the entire advance from the 2011 low to the 2014 high, making it an important Fibonacci level.

“A break below 1,082,” added Ross, “that’s going to open the floodgates in the Russell. I would be a seller right here in anticipation of that.”

To see the full discussion on the Russell 2000, with Seaburg on the fundamentals and Ross on the technicals, watch the above video.