Rotation into small cap stocks is the most discussed stock market theme over the last week and rightly so. There’s likely more upside ahead, according to the charts. The iShares Russell 2000 ETF just logged a five-day move greater than 10%, which last happened during the powerful snapback in April 2020 post the COVID crash. With IWM already up 25% from the October 2023 low even before this last spike, it’s clear this is a completely different trading environment compared to spring 2020. In fact, this big move has pulled IWM’s 14-day relative strength index all the way above the 80 level. The indicator only has surpassed 80 three prior times since the internet bubble burst in 2000: September 2017, November 2016 and June 2003. Additional upside followed each time. So, while the short-term pop has been nothing short of historic, seeing small caps continue to rally from last fall shouldn’t be surprising. This is best viewed from via several longer-term charts. Weekly breakout Here’s the weekly chart that clearly depicts IWM breaking out from a two-and-a-half-year bullish inverse head-and-shoulders pattern. The sideways price action in 2024 ultimately formed the pattern’s right shoulder, which IWM broke out from last week… and followed through upon the last few days. Should this breakout hold, the upside target would be near $260. As is clear, that objective is considerably higher than the 2021 peak, which was the last time IWM made a new all-time high. What’s next? The obvious question then would be this: If IWM does, in fact, make a new all-time high, what happens next? Well, the ETF has rallied back after a substantial correction three prior times since 2011, and each time IWM has formed a large bullish pattern — just like this one. Of greater significance, the ETF eventually broke out and continued to advance each prior time… as displayed on this monthly chart. Here is the percent move for each prior period’s low point to the breakout area (green) and then the percent move from the breakout zone to the next peak (blue). In other words, IWM will be up more than 50% from its most recent low if/when it gets back to its 2021 high. That’s a huge move, but if it follows the same pattern as it has over the last 15 years, it could have further to go from there. IWM vs. S & P 500 So, what are the odds of IWM continuing to outperform the S & P 500 after a potential multi-year breakout? First, notice how well the IWM/SPX relative line performed as it rallied from a key low to a peak since 2011. Conversely, during the three times that IWM has broken out to new highs in absolute terms, the IWM/SPX relative line has declined soon thereafter. In fact, the relative line has been diverging from IWM for 13 years and hasn’t made a higher high since 2011. If this trend continues, then the small cap outperformance could fade again after IWM makes a new high. The bottom line is that before the last few days of explosive movement, IWM had taken its time coming back post the 2022 bear market. But from a longer-term perspective, this is nothing new. While past performance does not predict future results, IWM has shown it can break out to new all-time highs before… and keep moving higher. One thing it has not done in quite some time is outperform the S & P 500 for an extended period after breaking out. That, especially, is something to keep in mind in the weeks and months to come. -Frank Cappelleri Founder: https://cappthesis.com DISCLOSURES: (None) All opinions expressed by the CNBC Pro contributors are solely their opinions and do not reflect the opinions of CNBC, NBC UNIVERSAL, their parent company or affiliates, and may have been previously disseminated by them on television, radio, internet or another medium. THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . THIS CONTENT IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSITUTE FINANCIAL, INVESTMENT, TAX OR LEGAL ADVICE OR A RECOMMENDATION TO BUY ANY SECURITY OR OTHER FINANCIAL ASSET. THE CONTENT IS GENERAL IN NATURE AND DOES NOT REFLECT ANY INDIVIDUAL’S UNIQUE PERSONAL CIRCUMSTANCES. THE ABOVE CONTENT MIGHT NOT BE SUITABLE FOR YOUR PARTICULAR CIRCUMSTANCES. BEFORE MAKING ANY FINANCIAL DECISIONS, YOU SHOULD STRONGLY CONSIDER SEEKING ADVICE FROM YOUR OWN FINANCIAL OR INVESTMENT ADVISOR. Click here for the full disclaimer.
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