Does The Market Have Another Ace Up Its Sleeve?

The Trump trade has been delivering blackjacks to bullish players since the election. But if you’ve played the game, you know all too well that hitting blackjack after blackjack means the face cards and aces are disappearing with each hand, leaving players with continually lower chances for success.

As I write this, the market has now risen for 22 weeks without a pullback, which is akin to players getting 22 blackjacks at a six-deck table with no shuffle. With only two more aces in the shoe, the chances of striking another big win decrease.

After a massive string of wins, it’s sometimes a good idea to pull your bets off the table and wait for a reshuffle, especially if the dealer is holding an ace.

The market is the house in this metaphor, and its ace is a combination of overstretched valuations, economic inconsistencies, presidential risks and a technical warning signal in small caps. If these factors continue, it could mean a nasty loss for you and the other players. 

I’m Worried About Small Caps 

I’m particularly concerned about the performance of the Russell 2000 small-cap index. This group of smaller companies was expected to be the big breakout index of the year. Trump’s policies were expected to swell Americans’ pockets with spending money and drive confidence and domestic spending through the roof.

Unfortunately, neither prediction has come to fruition, and the recent lack of real fundamental catalysts has taken its toll on the index. So far, 2017 performance has been abysmal. Given the initial excitement surrounding small caps and the subsequent letdown, I believe this lack of performance is a sign that investors see bigger problems looming.

Famed hedge fund manager Paul Singer not only pulled $5 billion in bets, he also believes “all hell will break loose” in the market.

Mr. Singer may have more of a doomsday outlook than most, but based on the charts alone, the Russell 2000 ETF (NYE: IWM) looks set for at least a pullback down to $135 — a level just above important technical signal. And if news and data flow continue to deteriorate, things could get worse — at least temporarily. 

Stats And Small Caps

In 30 weeks since the presidential election, the S&P 500 logged nearly 15% in gains and only moved lower in eight of those weeks. The Russell 2000 small-cap index, however, was down in 50% of those same 30 weeks and gained about the same 15% since the election. But while the S&P is up nearly 10% in 2017, the Russell has barely eked out 4%. 

The data tell me that the Trump consumer trade might not be as strong as many believe. The consumer-heavy stocks contained in the Russell simply aren’t performing, and given the fading excitement of our new president and dwindling consumer confidence, I simply don’t see an upside catalyst.

While Russell 2000 earnings per share (EPS) have improved, they are only back to the levels we saw in 2016 — not any higher than that — yet shares of the index are nearly 20% higher than they were early last year.

The reality is that gains in stocks are mostly built on faith — faith that the economy will somehow extend and accelerate one of its longest expansions in history, and that Trump will bestow a magical gift on the economy and stocks in the form of bigger earnings and better-than-expected GDP growth. 

Inflation remains weak, and consumer confidence is slipping (two months in a row now). Trump’s newly released budget is balanced but requires nearly double the GDP growth that we experienced in 2016. As an unbiased and objective analyst, I still don’t see the catalysts. Maybe a massive corporate tax cut will help big companies, but I still don’t see the huge benefit for small businesses.

The bottom line is that fundamentals don’t exactly spell bullish breakout for the Russell 2000, and the pattern currently forming in the IWM chart is one of the most powerful indicators of a correction.

That’s why I recently shared the details of a bearish options trade for IWM with readers of my premium newsletter, Profit Amplifier. If the trade works out as planned, we can grab a potential 27% gain from the technical follow-through in the Russell 2000 over the next couple of months.

Unfortunately, I can’t share all the details with you today. But if you’d like to learn more about how to navigate the world of options to make quick gains without taking on excessive risk, you can go here. In the meantime, if you’re in small caps, be warned…