by Bryan Perry

November 23, 2021

This is my third installment in a series advocating going long the Russell 2000. It is also likely my last set of thoughts on this topic because after this week, it’s my view that the train will have left the station. And it’s a non-stop train express that likely won’t pull into the next station until it has sped ahead 40% to 50%.

That’s both a fundamental and technical forecast. Let’s look at the fundamental side first. The world is awash in liquidity and the global total of QE is still expanding the money supply. At the most recent FOMC meeting, Fed Chairman Jerome Powell stated that the tapering process will involve a $15 billion monthly reduction from the current $120 billion per month in bonds the Fed is currently purchasing.

The buying of Treasuries and mortgages to the tune of $105 billion per month is still a huge amount of stimulus with the Fed slowly taking its foot off the gas. On the current schedule, the reduction in bond purchases will conclude in mid-2022. Fed officials have said they don’t envision rate hikes beginning until tapering is finished, and projections released in September indicate one increase at most next year.

Fed Funds Rate Projection Index Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Much has happened since September, when the world was on a strong trajectory to rid itself of Covid-19 due to rising vaccination rates and lower trending caseloads, hospitalization, and mortality rates. Within the past few weeks, however, Covid cases are once again spiking, primarily across Europe, prompting a re-imposition of a national lockdown and mandatory vaccinations in Austria.

The latest wave of Covid-19 cases is hammering Europe, with a number of countries seeing record daily infections, resulting in the imposition of partial lockdowns and placing more restrictions on unvaccinated people. In Germany, more than 65,000 new cases were reported in one day, a new daily record, with health officials warning that the true number of cases could be double or triple that number, since many avoid testing or vaccination. And both the Netherlands and France are reporting record new case growth.

Daily New Confirmed COVID-19 Cases in Europe Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Any plans that the European Central Bank (ECB) might have had about tapering QE are now on hold as economic activity is at risk of a sudden slowdown. It’s “déjà vu all over again” in Europe, and the fact that we are heading into the winter months only complicates the transmission rates of the virus. The obvious fear arising out of Europe is the potential impact of loosened travel restrictions in the U.S.

The point here is that, as attractive as Europe might have appeared to allocate investment capital to, it is not so appealing now, when the risk of a widespread pause in the reopening of that region has materially increased. Hence, the U.S. market and specifically those companies whose business models serve the domestic economy remain the safer haven for more predictable returns – that being small- to mid-cap.

The bullish move in the U.S. dollar also deserves comment. Both gradual tapering and incrementally higher bond yields are driving the value of the dollar higher relative to other major currencies. The dollar index (DXY) formed a clear double bottom between January and June, then it put in a high flag pattern during late September through October and subsequently broke out to the upside in November.

A strong dollar is a major headwind for profit margins of multinational corporations, especially those that generate more than 50% of their revenues from outside the U.S. As the Fed continues to move down the path of nominal tapering and rates creep higher, the path of least resistance for the greenback remains higher. This structural dynamic is also bullish for companies where the majority of business is dollar-based or where goods and services are sold within the U.S. – specifically small- to mid-cap companies.

United States Dollar Index Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Lastly, inflation is still a problem, much of it caused by snarled global supply chains and tight labor markets. Last week, Walmart noted in its earnings release that it and other companies are “managing supply chain issues by rerouting products to less congested ports and extending overnight hours to unload cargo, and that while higher labor costs were adding to expenses, they were being offset by sales growth.” Here, too, a strong dollar means greater buying power when importing raw materials and goods.

Once again, this forex variable skewed to a strong dollar favors the interests of domestic companies serving markets inside the U.S. – meaning small- to mid-cap companies, to be precise.

There are a few ways to play a potentially bullish U.S. small-cap rally that is dominated by the Russell 2000 Index. The first is to buy the iShares Russell 2000 ETF (IWM) as the most conventional avenue to get long the index. More aggressive investors will trade a leveraged instrument like the Direxion Daily Small Cap Bull 3x Shares ETF (TNA), which provides three times the reward, but also three times the risk. For income investors, the Global X Russell 2000 Covered-Call ETF (RYLD) and its lofty 11.30% yield coupled with a monthly payout might be of interest. (I have no position in IWM, TNA, or RYLD).

Russell 2000 iShares Exchange Traded Fund Index Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

This chart of IWM is one of the most pristine technical charts investors could hope to see in an index. Following nine months of consolidation, IWM broke out earlier this month and has back-and-filled 50% of that recent gain in textbook style. If charts don’t lie – and normally they don’t – then Christmas could come early for those that take this breakout in the Russell 2000 to heart. Have a wonderful Thanksgiving!

Navellier & Associates owns Walmart (WMT) in some managed accounts.   Bryan Perry does not own Walmart (WMT) personally.

All content above represents the opinion of Bryan Perry of Navellier & Associates, Inc.

Please see important disclosures below.

About The Author

Bryan Perry

Bryan Perry

Bryan Perry is a Senior Director with Navellier Private Client Group, advising and facilitating high net worth investors in the pursuit of their financial goals.

Bryan’s financial services career spanning the past three decades includes over 20 years of wealth management experience with Wall Street firms that include Bear Stearns, Lehman Brothers and Paine Webber, working with both retail and institutional clients. Bryan earned a B.A. in Political Science from Virginia Polytechnic Institute & State University and currently holds a Series 65 license. All content of “Income Mail” represents the opinion of Bryan Perry

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