Russell 2000: Brace for a sell-off – Morgan Stanley, Jeremy Grantham

The Russell 2000 index has been muted in the past few days as investors assess the next Fed action and the ongoing earning season. The index, which tracks the biggest small-cap companies in the US, was trading at $1,800, where it has been in the past few days. This price is ~5.3% above the lowest point in March.

Morgan Stanley warns about US stocks

The Russell 2000 and other American indices are at risk of a major meltdown. This is according to Morgan Stanley’s Mike Wilson. Wilson, who was voted as the number one analyst in Wall Street, has been one of the top bears in the industry.

In a statement, he warned that stocks are facing more headwinds than analysts are expecting. The biggest risk is that earnings growth has slowed and that the liquidity crisis could make the situation worse. He said:

“Historically, when forward EPS growth goes negative as it is today, the Fed is cutting rates, not hiking. However, the Fed has been hamstrung by inflation, making this cycle a historical anomaly in this respect — ultimately a near-term headwind for equities, in our view, until an easing cycle begins.”

Earnings growth so far has been a bit weak. In its most recent earnings insight, FactSet wrote that the blended earnings growth in the quarter was -6.2%. If this is the final figure, it will be the worst figure since Q2 of 2022 at the height of the Covid-19 pandemic. As shown below, the net profit margin of companies in the S&P 500 index has been falling after peaking in 2021.

Mike Wilson is not the only bear in the market. In a recent interview, Jeremy Grantham of GMO, warned that the S&P 500 index could drop by as much as 52% to $2,000. 

Russell 2000 forecast

Russel chart by TradingView

The Russell 2000 index has moved sideways in the past few days. Along the way, it has formed what looks like a bearish flag pattern that is shown in red. In price action analysis, this pattern is usually a bearish sign. 

The index has also dropped below the 25-day and 50-day moving averages while the Relative Strength Index (RSI) has risen above the neutral point at 50. Therefore, there is a likelihood that the index will soon have a bearish breakout as sellers target the key support at $1,700.

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