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  • The Small Caps Have Broken Out!

The Small Caps Have Broken Out!

Exposure Status: Moderate Risk

OVERVIEW
Buy The Rumour, Sell The News?

Good morning, traders!

We wanted to share some interesting news about today’s May Personal Consumption Expenditures (PCE) Price Index which will come out one hour before market open. It looks like inflation is going to continue to decline, thanks to falling gas prices and more deflation in consumer goods and this is what the market is expecting to see today.

On an annual basis, PCE inflation in May should slow to its lowest level since early 2021, which would be a significant step toward the Fed’s 2% target. There's some optimism here since inflation has been mostly flat since the start of the year. The drop in gas prices in May is a big factor, and that's pretty unusual for this time of year when gas prices typically go up. Healthcare costs have also only seen a modest increase.

This progress with the Fed’s preferred measure of inflation could lead to interest rate cuts later this year, which would definitely reassure investors. People are watching the data closely to see if this downward trend in consumer price growth continues. There's also some continued weakness in prices for goods, with consumers cutting back on discretionary spending. This is causing some retailers to lower prices, which is further helped by a strong dollar and falling import prices.

According to FactSet’s consensus estimates, economists expect the overall PCE Price Index to rise by 2.6% year-over-year in May, a bit lower than the 2.7% increase in April. On a monthly basis, it's expected to stay flat from April, at 0.26%. All these predictions are just that—predictions. We’ll find out what actually happens an hour before the market opens.

Yesterday’s big breakout in the small caps could be driven by this prediction that the PCE will come in lower. The market is feeling optimistic and reacting positively to the possibility of better news on inflation.

What Does This Mean?

Basically, this should be good news for the economy and the stock market. It would show that inflation is gradually slowing down, which is what we want. If this trend continues, we’ll get closer to the Fed's target of 2%, a healthy level for economic growth.

The unusual drop in gas prices and the modest rise in healthcare costs are helping this slowdown. As consumers spend less on non-essential items, retailers are cutting prices, supported by a strong dollar and cheaper imports. If this keeps up, we should definitely see the Federal Reserve cut interest rates later this year. This would be great for borrowing costs and overall economic stability, as low borrowing costs really fuel businesses, especially smaller capitalization publicly traded companies, which rely on “cheap” money to fund their growth through financing and debt.

Nasdaq

QQQ VRVP Daily Chart

The Nasdaq is looking strong with three consecutive sessions making higher lows and riding the daily 10-EMA without any issues. One thing to keep in mind is that there's significant supply at $434-$438, evident by the big volume cluster on the visible range volume profile, which is mostly yellow (indicating selling volume) and that will be tricky to break through especially of the QQQ gaps up just below that zone as it is doing now.

A few large tech stocks like Microsoft and Meta have been driving the QQQ higher and keeping the Nasdaq afloat, even as the recent pullback caused by Nvidia seems to be coming to an end.

We'll see today how the broad market reacts to the PCE data, but as it stands, the QQQ is looking healthy, and big tech stocks shouldn’t have too much to fear.

S&P Midcap 400

MDY VRVP Daily Chart

The midcaps are still seeing a heavy influx of buying pressure, defending a breakdown below their ascending support level at $530. This is very bullish action, with the MDY forming a clear bull-flag on the daily chart, now a multi-week volatility contraction pattern (VCP) characterised by a drying up of volume as the price action tightens along the daily 10, 20, and 50-EMAs.

For the bullish trend to continue, we really need to see big buying come in to take over the point of control (POC) at $535, turning it into support instead of resistance.

How the MDY behaves today will strongly depend on the PCE data and how the market responds to it.

Russell 2000

IWM VRVP Daily Chart

Great news for the small caps—they've finally broken out above their volatility contraction pattern (VCP) and are showing a strong gap up in pre-market trading towards their point of control (POC)!

This is really positive to see, especially considering the recent market rotations we've been discussing. But, let's not get ahead of ourselves. We need to see the IWM (small caps ETF) actually hold above $202 in this new range. Historically, it has a tendency to gap up strongly and then fade during the day.

Assuming the PCE data sparks a positive market reaction, we might expect the IWM to fade a bit in the first hour of trading to close this gap. After that, it would be ideal to see a green doji candle or a green top hammer candle signaling that buyers are overcoming selling pressure, which would set a positive tone for the week ahead.

Of course, everything hinges on the PCE data, so let's keep that in mind and approach today with cautious optimism.

DAILY FOCUS
Either Go Hard Today Or Wait For Monday

Today, how the stock market behaves is really uncertain. There’s a common pattern known as “buying the rumor, selling the news,” where traders can make significant gains around news events, especially big economic data reports.

There’s a possibility that the market might react negatively to positive data. Yesterday’s strong gains in the IWM and QQQ could have been driven by expectations built up over the past two days from various institutions and analysts. If the actual PCE data confirms these expectations, some traders may decide to take profits, leading to a pullback.

Despite this cautious outlook, we’re leaning towards optimism. Recently, we’ve seen small caps like ROOT & DRCT breaking higher and holding onto their gains, unlike some others that have faded in previous sessions (like AFRM).

As we approach the day, we’re cautiously optimistic. We know the market sometimes sells off inexplicably around positive data releases, so we’ll be especially watchful in the first hour. If we see such behavior, we’ll hold off on entering new trades. However, overall, we maintain a bullish bias, particularly heading into Monday.

WATCHLIST
Add These To Your Watchlist

AMD: Advanced Micro Devices Inc

AMD Daily Chart

  • We're starting off today with AMD, a well-known large-cap technology stock that you're probably familiar with.

  • AMD is currently consolidating within its flag pattern and showing signs of making a breakout in pre-market trading, especially as the QQQ (Nasdaq ETF) is recovering from its minor pullback.

  • Given how other leaders in the sector like Nvidia have performed, AMD has the potential to make a strong move upward. It's definitely worth keeping AMD on your watchlist to

GCT: GigaCloud Technology Inc

GCT Daily Chart

  • GCT is looking very promising. It had a remarkable +300% run from its entry point in late 2023/early 2024 and has since been consolidating in a multi-month flag pattern.

  • The company is a leader in its industry, showing exponential revenue growth and robust fundamentals.

  • This is the more speculative pick on our radar right now, and we're closely monitoring it for a breakout in the upcoming trading sessions. Missing out on a GCT breakout would definitely be regrettable, so keep a close eye on it.

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This newsletter does not provide financial advice. It is intended solely for educational purposes and does not constitute investment advice or a recommendation to trade assets or make financial decisions. Please exercise caution and conduct your own research.

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