Russell 2000: First critical juncture of recovery rally at hand

Kevin Pendley | May 31, 2008 9:02am EDT | Comment

Rating: Unrated [rate it]

Small-cap stocks have been on a nice upside stroll since the March lows, pushing higher in an impressive recovery rally that was foreshadowed by a beautiful doji bottoming formation on monthly charts back in March. However, the easy part of the process is over, and the market now faces the first stern test of the bottoming argument.

Looking at the current chart structure, it seems like a no-brainer that the Russell 2000 (NYSE:IWM) is sitting on further upside action. After all, didn’t we just finish the month of May up 4.5% and at the highest monthly close since December 2007? I guess the old “sell in May, and go away” mantra didn’t work so well in small caps this year, as we cautioned it might not in this column at the beginning of the month.

So, with a 4.5% monthly gain in our pocket, 6-month high closing values carved out, and momentum with the longs, why is this important juncture for the bullish argument? Because the market is trying to push through 750, which not only stands for solid chart resistance, but also marks the 50% Fibonacci retracement line of the entire bear market collapse. As you can see on weekly studies, we’ve been trying to chip away at seller resolve in the 743-750 zone for three weeks without a convincing resolution and the market won’t stay in this range forever.

Looking at weekly charts, the recent range between 720 and 750 has been an upward consolidation base for the market, which is a very good sign. Building a foundation to attack 750 is much better than a big failure/reversal formation off that zone (which was a big risk going into last week’s action). If we get a decisive breakout above 750, then the next big test is at 760, then at 775, which represents 61.8% retracement of the bear market slide. Off a rectangle price projection, any move through either 750 on the upside, or 720 on the downside carries a target run of 30 handles. In addition, a similar little trading range breakout of 9 handles is visible on intraday charts, with the parameters set at 741 on the lows and 750 on the highs (carrying corresponding short-term targets at 759 on the upside, or 732 on the downside).

There is a little bit of a double top visible on daily charts, and the inside rise Friday lacked conviction. From a recent history standpoint, the Russell closed out above opening levels on monthly charts in May for the third consecutive month, but has not been able to put together four consecutive months in the green during the entire bear market span.

I believe we are at an important juncture here: a breakout through 750 carries a target move to at least 775, and a breach of that point would provide a technical basis to say that the bounce off the January and March lows was not just corrective in nature, but bottom-forming. Conversely, a failure here runs the risk of not only stalling at logical resistance at 750, but setting up a failure of 720, which would carry a target move down to 690. It wouldn’t destroy the bottoming process, but it would jeopardize the immediacy of a summer rally and would be especially painful for any Johnny-come-lately bulls who bought recently.

Looking ahead to this week’s action, if we do not tackle 750 quickly, then a retest of 720 could easily take place. If we push decisively through 750 amid a busy data week, then it clears the stage for yet another leg up in the recovery move, and a possible test of the final retracement line at 775.

The table below contains support and resistance points for the Russell 2000 to keep in mind heading into this week’s trading. For long-term traders, some of these key levels may remain in place for weeks...even months at a time. Those with a short-term horizon will lean toward levels that are more immediately in play. As time passes, we will build upon this table with levels that come into focus as important testing zones for trend analysis, and to act as road mark indicators for key reversal patterns.

From a trading perspective, I always keep a printout handy each day of my key support and resistance points for any stock or market I’m trading. It helps remind me of key areas to watch for signs of trend exhaustion, and also for potential entry/exit points for trades.

TECHNICAL ANALYSIS SUPPORT/RESISTANCE POINTS FOR RUSSELL 2000

- 890.16   upward channel resistance on monthly charts off 5-year run;
            also fits with potential upside breakout of congestion zone
- 860.00   projected “figure” resistance off 15-handle testing zones on the ’06 rally
- 856.48   record intraday high set July 13
- 855.77   July 13 close; record high daily and weekly close
- 852.06   Oct. 11 high; bearish reversal peak on daily charts
- 830.01   previous high from the February 2007 peak; key swing line of note
- 815.00   key swing line
- 801.00   congestion resistance zone from November-December 2006
- 775.03   61.8% Fibonacci retracement of the Aug. 2007 peak-Mar. 2008 collapse
- 760.06   March correction low; key approximate double bottom formation support;
            Near 50% Fibonacci of July ’06-’07 bull run; violated in November ’07;
            Key swingline to watch
- 749.88   50% Fibonacci retracement of the Aug. 2007 record peak-Mar. 2008 collapse
> 748.28   May 30 close
- 747.99   recent recovery peak set May 19; reversal pattern on daily and weekly charts
- 743.49   previous Aug. ‘07 collapse low; short-term support violated, now resistance;
            Also near chart gap left by Jan. 2008 employment report news
- 732.57   20-day moving average
- 720.50   recent trading range; chart support lows
- 712.50   chart-related support zone; short-term area to watch
- 706.93   20-week moving average; nice trend support for bull run; smashed on
            July/August 2007 collapse
- 700.00   “figure” swing line; no monthly close below here since Dec ’05 until Feb ‘08
- 685.00   20% decline off 2007 record highs; breached Jan. 2008
- 680.94   mild reversal low on daily charts Jan. 28; near 50% of the March ’08 bounce
- 668.58   July 2006 low; important bottom for summer correction
- 660.00   short-term downside target on wedge breakout; support zone
- 650.00   previous bear market move low set Jan. 22, 2008, critical support zone
- 643.35   recent move low set Mar. 10, 2008
- 614.76   October 2005 bottom; next major chart related downside point
- 591.00   50% Fibonacci retracement of the 2002-2007 bull market run

In addition to the printout of support and resistance points to watch, I also like to keep in mind where sudden volatility can spring into the trading mix from the typical release of economic data and Federal Reserve activity.

The economic calendar is stocked full of big releases this week, highlighted by Friday’s employment report. The week kicks off in style with Monday morning’s ISM Manufacturing data and serves up noteworthy releases every day leading up to the “big event” on Friday.

The table below highlights calendar event risk for this week, with the emphasis on various economic reports. Our table below has a special “Risk Factor” designation, which is simply my assignment of risk to that event, ranging from 0 to 5, with 5 marking the highest risk for volatile market swings.

CALENDAR EVENT RISK ASSESSMENT

RISK FACTOR REPORT/ITEM (all times Eastern)

4                   ISM Manufacturing Survey (Mon., 10:00 a.m.)
1                   Construction Spending (Mon., 10:00 a.m.)
1                   Fed’s Lockhart on the economy (Mon., 12:20 p.m.)
1                   Fed’s Bernanke on international panel (Tues., 9:00 a.m.)
2                   Factory Orders (Tues., 10:00 a.m.)
3                   Vehicle Sales (Tues., all day)
2                   Productivity (Wed., 8:30 a.m.)
3                   ISM Non-Manufacturing (Wed., 10:00 a.m.)
2                   Fed’s Bernanke at Harvard speech TBA (Wed., 2:00 p.m.)
0                   Fed’s Lockhart “Japan impact on econ” (Wed., 8:30 p.m.)
3                   Weekly Claims (Thurs., 8:30 a.m.)
0                   Fed’s Plosser “financial econometrics” (Thurs., noon)
4                   Employment Report (Fri., 8:30 a.m.)
1                   Wholesale Trade (Fri., 10:00 a.m.)
0                   Fed’s Evans remarks at payment fraud conf. (Fri., 11:15 a.m.)
0                   Fed’s Bullard “challenges in housing market” (Fri., 12:30 p.m.)
0                   Consumer Credit (Fri., 3:00 p.m.)