| Is
the Russell 2000 rebalance a sell signal? |
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| July 13, 2001
David D. Miller, President, NIBM |
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| [Ed. note: This
article was published in 2001 and correctly predicted the decline in the Russell 2000. To
see a similar article published in 2002,
click
here.] |
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| Since we began
writing market commentary in May of 1999, the Russell 2000 is the only one of
the four major indices to be higher now (+7.76% as of July 11, 2001) than it was on our
launch date in 1999. The investing public's increasing fascination with small cap stocks
in the wake of the collapse of big-cap tech stocks has increased the importance of this
index, as has the over $300B invested in funds tracking the Russell 2000. |
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| Once per year, the Russell Company rebalances
its index. This was not always so. According to the Russell web site, the index was
rebalanced quarterly from 1979 to 1986 and semi-annually from 1987 to June 30, 1989. As a
result of the NASDAQ crash and general devaluation of Everything Tech, the 2001 rebalance
was very large with over 1000 companies moving in and out of the Russell 2000. |
The Russell Company rebalances its indices
on June 30th each year. |
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| The increasingly large turnover at
rebalancing, combined with growing asset values at small cap funds, has created a rather
interesting trading pattern. This pattern has arguably been in place since 1995 and has
been especially apparent since 1998. Those who invest in small cap stocks or who own small
cap funds should take note of these patterns as they may well help avoid losses or at
least assist in the timing of buys. |
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| We've put together a table of the
Russell 2000's performance from 1990 (the first full year with only a single rebalance
event) to the present measuring the index's performance from the rebalancing date through
the end of the year. While there is no obvious pattern between 1990 and 1994, in 1995 a
pattern begins to emerge. That pattern is for the Russell 2000 to peak at some point
between the rebalance date at the end of June and a date within a few days of the July
options expiration date. In 1995, 1996, and 1997, the index put in second half lows within
three or four days of the July expiration, but recovered by the end of the year. |
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| In 1998, 1999, and 2000, however,
this pattern became more defined. In each of those years, the Russell 2000 climbed from
the rebalance date through the option expiration and then plummeted from there through the
end of July. The downward trend then continued to significantly lower levels later in the
year. |
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| Year |
Rebalance
Close |
July
Peak (date) |
Gain |
July
End |
Decline
from Peak |
| 1998 |
457.39 |
463.64 (16th) |
+1.37% |
419.75 |
-9.47% |
| 1999 |
457.68 |
465.80 (15th) |
+1.77% |
444.77 |
-4.51% |
| 2000 |
517.23 |
545.17 (17th) |
+5.40% |
500.64 |
-8.17% |
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| In every instance, not only was the
July end number significantly lower than the July peak, it was also lower than the value
of the Russell 2000 at its rebalancing. In those three years, the earliest the Russell
2000 regained the level it had at the rebalancing date was December. In 2001, the pattern
may be altering itself somewhat as the Russell has been in a free fall since its
rebalancing date, losing 5.20% in the first five trading days of July. |
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| Short-term traders should easily
recognize the trading opportunities inherent in this pattern. Long term investors can also
make use of this data either as part of a second-half diversification effort or when
timing additions to their small cap portfolios. While historical trading patterns even of
large indices like the Russell 2000 are not always predictive of future patterns, there is
a defined enough pattern here to at least warrant a cautious attitude for small cap owners
and buyers and signal a potential opportunity for small cap short sellers. |
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| Ed. Note:
Here is a chart of Russell 2000 performance from 1990 to 2000 that was not in the article
as it appeared in the IFC newsletter. The chart was available to readers on our site,
however. |
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|
| Year |
Value
at beginning of the year |
Value
at Rebalancing |
Value
at July options expiration (date) |
July
low (date) |
Value
at end of July |
Second-half
low |
low
date |
Value
at end of the year |
| 1990 |
168.31 |
169.12 |
166.82 (20th) |
161.51 (30th) |
169.12 |
118.82 |
10/31 |
132.20 |
| 1991 |
132.20 |
167.61 |
172.87 (19th) |
167.01 (5th) |
172.76 |
167.01 |
7/05 |
189.91 |
| 1992 |
189.91 |
188.64 |
190.42 (18th) |
185.81 (8th) |
194.74 |
185.81 |
7/08 |
221.01 |
| 1993 |
221.01 |
233.35 |
236.16 (17th) |
233.19 (7th) |
236.46 |
233.19 |
7/07 |
258.58 |
| 1994 |
258.58 |
240.29 |
245.62 (16th) |
240.68 (6th) |
244.06 |
235.16 |
12/09 |
250.36 |
| 1995 |
250.36 |
283.63 |
290.52 (21st) |
283.74 (3rd) |
299.72 |
283.74 |
7/03 |
315.97 |
| 1996 |
315.97 |
346.61 |
321.54 (19th) |
307.77 (24th) |
316.00 |
307.77 |
7/24 |
362.61 |
| 1997 |
362.61 |
396.37 |
405.89 (18th) |
394.13 (1st) |
414.48 |
394.13 |
7/01 |
437.02 |
| 1998 |
437.02 |
457.39 |
462.36 (17th) |
419.75 (31st) |
419.75 |
310.27 |
10/08 |
421.96 |
| 1999 |
421.96 |
457.68 |
465.26 (16th) |
441.58 (29th) |
444.77 |
408.90 |
10/18 |
504.75 |
| 2000 |
504.75 |
517.23 |
522.70 (21st) |
490.22 (28th) |
500.64 |
443.80 |
12/20 |
483.50 |
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© 2001 NIBM. All
Rights Reserved. |
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