Russell sinks at closing

Kevin Pendley | May 14, 2008 4:40pm EDT | Comment

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Small-cap stocks extended the upward march much of the day Wednesday, lifted by tame consumer price inflation data this morning, which eased some concerns that the Federal Reserve’s tightening gun was coming out of the holster sooner than expected. However, the rally sputtered in the final hour of trading, and the Russell 2000 (NYSE:IWM) closed down 0.79, or 0.11%, at 736.07. On the face of things, it might not seem like a big deal to only lose 0.11%, but a lower close when making new five-month highs serves up a potential topping pattern on charts that raises a caution flag heading into action Thursday and Friday.

After yesterday’s glut of Fed speakers inundated the market, many traders came away with the interpretation that Federal Reserve policy makers were turning hawkish, preparing to fight inflation. However, this morning’s CPI reading was seen as a sign that inflation remains at bay — at least for now — which should buy the market some time before rate hikes become plausible. The CPI headline number came in at 0.2%, just below the 0.3% forecast, while the “core” reading, which excludes food and energy, was up 0.1%, also below the 0.2% projection.

While gains in large caps were fairly broad-based Wednesday from a sector perspective, homebuilder and retailer stocks appeared to be especially giddy about the prospect of delaying rate hikes down the road. The S&P Retail Index jumped about 1.6% on the day, with Macy’s Inc. (NYSE:M) rising about 4%. Among homebuilders, DR Horton Inc. (NYSE:DHI) was up over 2% and Lennar Corp. (NYSE:LEN) jumped over 5%.

Among individual small caps, Spire Corp. (Nasdaq:SPIR) jumped 13% on brisk volume after reporting record first-quarter revenues. National Coal Corp. (Nasdaq:NCOC) was up about 13% without fresh news and CommVault Systems (Nasdaq:CVLT) gapped higher, gaining some 13% via positive earnings news. On the downside, Young Innovations (Nasdaq:YDNT) was off about 14% without any apparent fresh news to power the slide. NN Inc. (Nasdaq:NNBR) was down about 7%, also without news.

Small caps struggled today in the shadow of gains posted on large-cap indices, which is a little bit of a caution signal for action the rest of the week. The market is overbought on some short-term momentum readings, which could exhaust immediate buying interest.

In addition, there is some concern about the CBOE’s Volatility Index sinking to the lowest level since last October. The VIX is a nice proxy for fear and complacency in equities, with low readings coinciding with complacency and high readings to fear. Typically, a low reading in combination with high stock values can foreshadow a nasty top, and it’s hard to overlook the fact that when the VIX was at these levels last October, the market was near a major peak.

Speaking of volatility and options, the May options expiration is just around the corner on Friday. It’s a “double witching” variety expiration, comprising equity and cash index products. Typically, one would anticipate a bullish bias for the May expiration simply because price action the last quarter has been higher. However, Scott Fullman, analyst with WJB Capital Group said in an email interview with SmallCapInvestor.com, “I think there is a slightly negative bias based on the high open interest on the 1,400 line for the S&P 500.” The SPX closed at $1,408.66 Wednesday, so if the high open interest “pulls” the market back to that major strike price, then it would infer a dip of about 0.5% in the SPX by Friday’s close.

From a charting standpoint, the Russell formed a pattern closely resembling a troubling “tombstone doji” on daily candlestick charts. These patterns form when the open and closing price is near the session lows, and this formation at a market rally point often signals that the battle for the bulls is over. In traditional chart theory, it means that the market rejected an intraday move to new highs today, which is always a red flag. In addition, the market abruptly faltered today after testing important resistance in the 743 area. Looking ahead to Thursday, resistance remains at 743, then at 750, while support is at 731 and 726.

In addition to sorting out the troubling chart patterns, the market must navigate through another batch of economic data Thursday morning, including the NY Manufacturing Survey, Weekly Claims, Industrial Production, the Philly Fed Survey and another speaking appearance by Fed Chair Ben Bernanke.