Welcome to Technical Watch and thanks for the RUT RS status update.
While on the RUT topic, it may be useful to take the pulse of RUT sentiment, breadth, and money flows.
Remaining in the spirit of relative strength, below is a chart of the unweighted RUT average divided by the traditional weighted RUT. The weighted distribution of RUT components is not skewed toward a few larger stocks like some indices, but nonetheless, there are subtle differences between the weighted and unweighted RUT. Since mid-February, the weighted RUT version has been slightly stronger than the unweighted RUT.
However, the choppy nature of the RS decline suggests the RUT component universe in its aggregate continues to show periodic life, and is making yet another assault on its controlling resistance line. A clean break of the R-line would be an indication RUT would have the energy for another robust upmove.
The RUT component AD McClellan Oscillator (MCO) reached a nice, but not too oversold level last week (-64), and has since rebounded to -21. Its next objective is the controlling R-line, then the zero line. To muster a sustainable rally, the RUT AD MCO must find its way above the zero line and remain for a few weeks. A failure to exceed the zero line next week, will likely result in a lower price low than posted last week, setting up a divergence in the AD MCO wrt price before charging to new price highs.
The RUT AD McClellan Summation index (McSum) remains in positive territory (currently at +233) since the latter half of November, 2005, a testimonial to the strong liquidity in the small caps. However, nearly five months above its zero line is quite a feat, and time will tell if the indicator will need to regroup below zero prior to gaining sufficient energy for a robust upmove. Note how the important +500 line and controlling R-line continue to stop the RUT McSum from really taking off to the upside.
On the RUT money flow side, next is the $ weighted Up-Down volume ($UD) MCO. For RUT, I prefer using the $UD indicators rather than the traditional UD volume tools, due to many very low priced RUT components with large daily volume that can skew the volume indicators either direction. The $UD indicators provide a "fairer" balance between the low, medium, and higher priced components with respect to distorting influences by some of the high volume, low priced issues.
Like the RUT AD MCO, the $UD MCO achieved a nice, but not "too" oversold posting of -65 last week. Extreme oversold MCO postings in the RUT MCOs, lower than -85, often result in short swift rallies, but inevitably result in 2% to 5% lower price lows in the coming months. Moderately oversold MCO levels as seen last week, are often (but not always) followed by nominal lower lows in the near term, but set up the classic positive divergences that lead to robust rallies.
The RUT $UD McSum has remained above its +500 line since November 2005, illustrating the relentless positive net money flows into this group. As with its AD McSum cousin, several months above +500 is a sign of strength, but also raises the possibility the index internals need a rest. A break out of its declining flag, in either direction will likely set the price tone for the intermediate term.
Small cap related sentiment indicators are showing signs of uncertainty, and are definitely not in the range typically associated with IT tops.
First is the NAV adjusted asset flows of the Rydex Mekros fund, whose price moves 1.5x percentage-wise, relative to RUT. The Mekros fund is considered the "hot money" vehicle of small cap bulls. This indicator could be classified in the mildly bullish zone of its range over the past year or so. A lower reading would be preferable for a sustained price rally, but it has been interesting how skittish the bulls get (assets drop quickly) on any mild decline.
A little over two years ago, Rydex introduced a small cap inverse, or short fund. Its asset flow history is not extensive, but the money flows into this fund have been interesting over the past few weeks. The NAV adjusted asset flows, on both a daily and 10 day MA basis, have recently reached levels second only to the October 2005 price lows. As observed earlier, this fund has a limited history, but the behavior of the Rydex traders in this fund over the past several weeks sure smells of top picking, possibly just hedging, but it certainly suggests uncertainty in the small caps.
Last is an indicator developed to measure fear or complacency in a given index using the volume of the IWM ETF in both its options and ETF volume. The indicator is derived by comparing the daily volume of the IWM options and ETF volume against their respective 50 day MAs. I then multiply the two scalar adjusted ratios and smooth the results with a 9 day EMA.
The theory behind this indicator, is when volume in the IWM ETF and options increase to higher levels relative to their detrended values, the action flags trader enthusiasm for leveraged IWM positions (usually heavily skewed toward puts) or the very liquid IWM ETF. For the IWM options, I use the "all exchanges" volume published by the OCC, thus the history of this indicator is limited as well, since the data is available only since late 2003.
However, it has done a decent job of identifying fear in the IWM traders. 100 is the neutral value for this indicator, and postings above 150, are usually followed by price rallies of some degree after the indicator rolls over. The high last week was 164, and is nowhere near the levels seen a some important price lows, but note the August 2004 rally was kicked off a levels comparable to levels achieved last week.
IMHO, the current configuration of various small cap indicators could be supportive of a price rally from here, but there is a risk of more near term weakness setting up potential nice divergences, and perhaps driving sentiment indicators to more solid extremes. However, any near term weakness will likely be muted on a percentage basis, and continued monitoring of RS and other indicators will provide useful clues in what to expect in that event.
Cycle-wise, some respected Hurst cycle analysts are looking for a 20 week nesting of several cycle harmonics in mid-May. Cycle harmonics nesting can result in noticeable price lows, but have often been points in time where prices rise out of (consolidation patterns), and not necessarily a V-type price bottom. By following the behavior of the small cap underpinnings, perhaps the action over the coming days and weeks will provide clues of what price patterns the 20-week cycle low will emerge from.