US small caps making a break higher?

Summary:

• US2000 breaks above resistance at 1534

• Small cap index has been lagging large caps 

• US PPI beats forecasts

While the attention for US indices often falls on the large cap benchmarks (US500, US100, US30), the small caps (US2000) can provide further insight and are seen by some as a better proxy on the domestic economy. Yesterday was a mixed day for the large cap markets, with some early weakness subsiding and a bid into the close on more hopes of an improvement in the US-China trade relationship saw the benchmarks end the day little changed. The small caps however were stronger throughout and managed to post an impressive daily gain, and in doing so cleared the prior resistance level around 1534.

The Russell 2000 rallied to its highest level since July yesterday, and has extended further this morning. Price is now back above the 1534 resistance level. Source: xStation

The correlation between large and small caps has been weakening over the past 12 months with the former outperforming the latter. This could be seen as unusual given that larger multinational firms are more exposed to the US-China trade tensions. One explanation for this could be that smaller firms are more sensitive to economic developments and are therefore feeling the impact of a slowdown more keenly, while money managers may be also less reluctant to invest in the space. Either way, a notable divergence can be observed and S&P500 bulls would like to see further gains in the Russell to support the strength seen in their own market.      

The divergence between the US500 and US2000 could be seen as a warning sign for US500 bulls. However, they will have been pleased to see the US2000 make a break higher yesterday. Source: xStation

While Thursday’s CPI data is more of a market mover, the recent release of US inflation data has perhaps set the scene against which tomorrow’s will be viewed. The PPI Y/Y for August rose to 1.8% from 1.7% prior with the consensus calling for another reading of 1.7%. A core reading, that strips out the effects of food and energy rose to 2.3% Y/Y, from 2.1% prior. These rising inflation figures will not be welcomed by the Fed who are expected to not just cut rates later this month but also a couple more times before year-end. If we get a similar reading in tomorrow’s CPI then the calls for a less dovish stance amongst rate setters will grow a little louder.

The decline in PPI readings may be coming to an end with both the headline and core ticking higher in August. Source: XTB Macrobond