Russell 2000 & Mid-Cap Stocks Surge on Fed Policy Tweak, VIX Falls

STOCK MARKET FORECAST: RUSSELL 2000 INDEX OUTPERFORMING S&P500, DOW JONES, NASDAQ AFTER FED POLICY ADJUSTMENT TO MUNICIPAL LIQUIDITY FACILITY

• Russell 2000 Index price performance is up nearly 9% over the last five trading sessions
• The Russell 2000 has gained more than the S&P 500, Dow Jones, and Nasdaq since the stock market selloff bottomed last month
• Fed monetary policy adjustments, such as expanded reach of its municipal liquidity facility, has crushed the VIX Index ‘fear-gauge’

Stock market investors have rejoiced the recent series of efforts made by global governments and central banks. In hopes of offsetting the likely unavoidable recession stemming from the coronavirus pandemic and its paralyzing impact on economic activity, the Federal Reserve and US Congress, for example, have injected unprecedented amounts of stimulus and liquidity into the financial system.

This broadly facilitated a recovery in trader sentiment and has corresponded with a solid rebound in stocks since last month’s bottom. The ongoing bounce in key US stock market benchmarks, such as the S&P 500, Dow Jones, Nasdaq and Russell 2000, just received another boost from increasingly accommodative Fed policy.

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RUSSELL 2000 INDEX STARTING TO OUTPERFORM DOW JONES, S&P 500, NASDAQ

Chart created by @RichDvorakFX with TradingView

The Federal Reserve announced an expansion of its Municipal Lending Facility (MLF) on Monday, which has helped push he Russell 2000 Index and mid-cap stocks higher in particular. This is seeing that the expanded MLF now includes smaller counties and cities, which will allow ‘substantially more’ entities to borrow and gain access to desperately-needed credit.

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With the Russell 2000 Index up 35% since March 23 when the coronavirus-induced stock market selloff bottomed, the benchmark of mid-cap stocks now has better performance than the S&P 500, Dow Jones or Nasdaq. This constructive development could offer a sign of encouragement for bullish equity investors – especially with month-end rebalancing right around the corner.

RUSSELL 2000, MID-CAP STOCKS STILL LAGGING YEAR-TO-DATE AS RECESSION RISK LINGERS

Chart created by @RichDvorakFX with TradingView

If the March 23 is truly the bottom in stocks, and market participants are in the midst of a ‘V-shape’ recovery, there could be potential for the Russell 2000 Index to prolong its outperformance relative to the S&P 500, Dow Jones and Nasdaq. This is considering that the Russell 2000 Index is down by more than 20% on a year-to-date basis and lags the other three major US stock market benchmark.

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That said, month-end rebalancing and sharp recovery in economic activity, if materialized, might encourage capital rotation away from large-cap stalwarts, like FAANG, in favor of relatively more attractive mid-cap stocks within the Russell 2000 Index. Nevertheless, there is a key outstanding risk that the ongoing stock market rally could be nearing its wits end despite the VIX Index ‘fear-gauge’ plummeting.

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Russell 2000 strength, along with the broader stock market recovery, hangs in jeopardy as investor complacency builds on the back of Fed liquidity. The likelihood that the coronavirus recession turns out worse than expected is pronounced. Downside risk faced by stocks is also echoed by the chance that either employment or consumer spending fail to bounce back as quickly as anticipated. On that note, market participants might want to take notice of the economic calendar for a detailed list of upcoming event risk and scheduled data releases with potential to strongarm the next direction of stocks.

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— Written by Rich Dvorak, Analyst for DailyFX.com

Connect with @RichDvorakFX on Twitter for real-time market insight