Small caps breadth vs. momentum, greedy commodities traders

Small caps overbought

The Russell 2000’s nonstop rally has kept a meaningful % of its stocks in overbought territory for a long time:

Historical cases in which more than 5% of small caps were overbought for 36 consecutive days led to more-bearish-than-random returns over the next 2-3 months:

This is a bearish factor, particularly when the Russell breaks its upwards-sloping trendline.

Momentum

Momentum remains a bullish factor for stocks, and thusfar momentum indicators have beaten contrarian indicators. The Russell 2000’s momentum is very strong: it’s 3 day RSI has been consistently elevated.

When 3 day RSI’s 2 month average was this high in the past, small caps usually pushed higher over the next 2 months:

This is a bullish factor, and directly contradicts the previous bearish factor (breadth). The stock market is a tug-of-war between momentum (trend following) vs. sentiment (contrarian). Thusfar momentum is winning.

Greedy commodities traders

If 2020 has taught us anything, it’s that “black swans” don’t just lead to downside risk. Black swans can also occur on the upside (much better than expected outcomes), particularly when central banks are printing like there’s no tomorrow. Everything surged this year, including commodities.

The CRB Commodities Index’s Fear/Greed indicator has been positive for 24 consecutive weeks. No surprise here given the near-vertical rally in commodities:

*Bloomberg’s Fear/Greed indicator is more a momentum indicator – it’s an oscillator¬†based on on-balance calculation of true range.

Historical cases of strong commodities momentum led to more gains over the next 6 months.

This is a bullish factor, and I think commodities will do well in 2021 as the global reflation theme continues.

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