Russell 2000 Earnings Could be Tip of Recessionary Iceberg

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chart via StockCharts

Just about anything can happen in the world of finance. The Russell 2000 is comprised of the 2000 smallest companies of the Russell 3000. While the Russell 2000 isn’t as widely followed as the S&P 500 or the NASDAQ, it could be the harbinger of tough times ahead.

Like just about every other measure of equity performance, the Russell 2000 had an amazing start to the year. It is up more than 13% so far this year. That kind of performance puts 2019 as a banner year for the Russell. The last time it had such a great start to a year was 2011.

Despite the big rise in value, there are problems brewing in the Russell 2000. Not only are earnings expected to decline by double digits, but there are also reasons to believe that there could be further earnings problems for a big slice of the Russell 2000’s component companies.

The Russell 2000 Tends to Lead the Larger Market

There is a reason why many market watchers pay attention to the Russell 2000’s performance. Smaller companies tend to react quickly to changes in the overall economic environment. That means that small-cap companies like the ones that comprise the Russell 2000 will lead the stocks out of a bear market, but they will also signal a flagging economy.

The fact that so many of the Russell 2000’s companies are expected to see a big fall in earnings is cause for concern

It is also worth noticing that while the S&P 500 is knocking on the door of new all-time highs, the Russell 2000 is far from the highs that it posted last summer. To be sure, an underperforming Russell 2000 isn’t strong evidence of an immanent market rout, but is isn’t a great sign either.

The Financial Question

Around a quarter of the Russell 2000 is involved in some sort of financial activity, which is bad news.

Various forms of inverted yield curves have been making news recently. While an inverted yield curve is an event that makes news, almost no one cares about shallow yield curves. Unfortunately, a shallow yield curve is almost as bad as an inverted one for most financial companies.

When a company relies on lower short-term yields and higher long-term interest to make money, a shallow yield curve is a big problem for earnings. Many of the Russell 2000 companies are in this exact position and could see bigger earnings issues emerge as 2019 unfolds.

chart via StockCharts

The real issue is that the financial sector is already on the defensive. The S&P 500 Financials topped out around February of last year, and haven’t recovered since.

As this earnings season develops, look for pain in the financial sector. There is nothing to stop the global economy from entering another recession, especially if the world’s major banks are teetering on the brink of the abyss.

Taken with the performance of the S&P500 Financial sector, the Russell 2000 could be an early indicator of major problems right around the corner.