Russell Erases 2023 Gains, Can it Recover?

The fallout from the banking chaos and the change in outlook from the Fed has been having an outsized impact on the premier gauge of small caps.

Tech Stands Out the Most

Traditionally, small caps are seen as attractive during periods of rising interest rates, assuming that smaller companies will be more agile in dealing with the change in circumstances. The Russell 2000 has another factor usually in its favour: Many regional banks. Banks tend to benefit when interest rates rise, as they see a larger net interest margin - assuming, that is, they've hedged their interest rate risk appropriately.

Given this situation, it's hardly a surprise that the Russell 2000 is now trading in the red for the year after gaining almost 14% by the start of February. The initial move higher mirrored risk appetite seen across the board, with the Nasdaq the largest beneficiary of an expectation that the Fed was reaching the end of its hiking cycle. But when the FDIC took over SVB, and it was speculated that rates wouldn't rise as much, the Nasdaq took off again, but the Russell 2000 remained under pressure.

Any Chance For Recovery?

Following the Fed's announcement that it would hike rates but change in language from an "ongoing" rate tightening cycle to more data dependent, markets are pricing in less monetary policy tightening. Risk remains off due to worries about the banking sector, which also drags on small caps. But the advantage of small caps in being more agile in dealing with rising interest rates is fading as the market expects rates to level off very soon. 

The focus returns to the banking sector, the main drag on the Russell 2000. So far, investors have hesitated to jump back into regional banks, despite a substantial drop in valuations, making many of them comparatively undervalued. Ultimately, smaller banks face a crisis of confidence - losing investor trust is fast, but recovering can take a very long time. As the dust settles on the SVB issue, investors might come back to supporting regional banks and remove weight from the Russell 2000. That supposes there is no other major issue in the banking space to spook them.

Russell 2000 in Pennant or Triangle

Russell 2000 found stiff opposition at the 2k handle after failing to soar past the 2040 resistance, erasing all yearly gains. If prices see some respite, we might form a triangle between 1870 and 1940, followed by further declines so long as bears keep pressuring under the 1700 hurdle. This, or a straight drop on the back of a pennant, should pave the way to 1300; the measured move from the 1700 handle (2040-1640).

Source: Spreadex

Key Takeaways

As a gauge of small-cap stocks, the Russell 2000 has been under pressure due to turmoil in the banking sector. Investors hesitated to return to regional banks, causing the index to erase its yearly gains. Ultimately, smaller banks are facing a crisis of confidence which will only be overcome when investor trust is regained.