The Russell 2000 Index lagged badly in the first half of 2019, stuck in a sideways pattern at the 200-day exponential moving average (EMA), but it could play catch-up with broad benchmarks in the third quarter. While the small-cap index and fund may struggle to post new bull market highs, top components should attract healthy buying pressure, offering more dynamic buying opportunities than gyrating tech stocks or overbought safe-haven plays.

The U.S. dollar (USD) may underpin sector gains in the coming months after hitting a three-month low in June. A stronger dollar supports small-cap rallies because it reduces overseas profits, lowering multi-national returns while benefiting small domestic operations. The USD has bounced at range support in reaction to the trade truce and could build on gains if positive economic news continues into second quarter earnings season.

Small caps typically perform well in the first quarter and then go into hibernation, booking limited gains into the seasonally positive period that starts in November. This year began in perfect alignment with seasonality, lifting the small-cap index to a four-month high in February, but the rally faltered badly in May. The index fell to January levels in June and crawled higher, and it is now trading about four points under the first quarter peak.

A range breakout would open the door to major resistance at the .786 Fibonacci sell-off retracement level, which is situated a few points above that price zone. Many financial instruments have reversed near similar levels in recent months, so it's probably not wise to expect a quick or easy path up to 2018's all-time high. However, upside potential will increase exponentially if the United States and China finally cut a trade deal.

Russell 2000 Index

Chart showing the share price performance of the iShares Russell 2000 ETF (IWM)
TradingView.com

The iShares Russell 2000 ETF (IWM) broke out above the 2015 high at $129.10 after the 2016 presidential election and entered a powerful trend advance that posted an all-time high at $173.39 in August 2018. It then fell in two major selling waves, coming to rest at breakout support in late December. The decline also found support at the .618 Fibonacci retracement level of the 2016 into 2018 uptrend.

The bounce into 2019 stalled near $160 in February, yielding a failed May breakout attempt, followed by a downturn that broke short-term range support near $150. The fund opened three points under February resistance on Monday morning and is now filling the gap. Look for a range breakout to stall quickly at the .786 retracement above $161 while continued upside sets the stage for a test of the all-time high.

eHealth, Inc. – Small-Cap Market Leader

Chart showing the share price performance of eHealth, Inc. (EHTH)
TradingView.com

eHealth, Inc. (EHTH), the sixth strongest index component, provides private health insurance exchange services. It came public at $25 in October 2006 and topped out at $37 in 2007, ahead of steep decline that bottomed out at $8.38 in November 2008. It rallied above the 2007 high in 2013 but failed the breakout just eigth months later, entering a major downtrend that posted an all-time low at $6.38 just ahead of the 2016 presidential election.

The stock mounted 200-week EMA resistance for the first time in nearly three years in May 2017, tested that level for a year, and took off in a trend advance that completed a round trip into the 2014 high in February 2019. The stock finally completed a breakout in late May and added about 16 points in June. The on-balance volume (OBV) accumulation-distribution indicator has lifted to a new high as well, supporting the uptick, while a five-year Fibonacci grid places the 1.618 extension right at the $100 psychological resistance level.

The Bottom Line

A stronger U.S. dollar could underpin small-cap stocks, funds, and indices in the third quarter, allowing this lagging sector to play catch-up with blue chips.

Disclosure: The author held no positions in the aforementioned securities at the time of publication.