VIDEO: What the Russell 2000, VIX and a Key Indicator Tell Us Ahead of the Fed

In today's Action Alerts PLUS Daily Rundown, AAP team member Bob Lang breaks down what recent outperformance of the Russell 2000, volatility and the McClellan Oscillator tell him ahead of next week's Fed decision.

Transcript

JD DURKIN: Good morning, subscribers, one and all. Mr. Bob Lang, the one and only, joins me now for a look at the technical landscape ahead of a very busy week for the Federal Reserve. Bob, thank you for being here. Let's talk about the Russell 2000. It has largely outperformed the S&P 500 in the past few trading sessions. Give me your take, Bob. What exactly is going on there?

BOB LANG: Well, we go back to the beginning of the year, JD, and we notice that the beginning of January to about the middle part of January, the Russell 2000 was performing just as well as the NASDAQ and the S&P 500. And then it kind of pulled back a bit. And then, of course, we saw the NASDAQ starting to move higher. That index is just crazy up this year, over 30%.

But as we started the month of June, JD, we saw that the Russell 2000, the IWM, was just about flat, maybe up 1% for the year, severe under-performance versus the S&P 500, the large caps, and the NASDAQ. But since then, we've seen a huge rally in the Russell 2000, a very broad index of 2,000 stocks, up almost 8 and 1/2% in about six or seven sessions. That's pretty incredible when you think about the components in there.

It's not a cap-weighted index, of course. It's just an equally weighted index, unlike the S&P 500 or the NASDAQ. But still, it's very impressive to see that broad participation in the market finally coming through. You know, a lot of the complaints, JD, over the past month, month and a half, is that only a few stocks had been carrying the market higher. And the statistics prove that out.

But still, when this broad participation comes in with the Russell 2000, it tends to drag the rest of the market along with it. So we think there's some upside here, as long as this Russell 2000 remains strong.

JD DURKIN: Nice to see the love be spread around a little bit and not solely consolidated in the hands of the Apples, the Microsofts, the alphabets, et cetera, although they have all, of course, been performing very strong year to date. The Russell 2000-- or rather, let's talk about the VIX. The VIX has been sharply lower as of late. You expect volatility, Bob, to spike as we get a little bit closer to Fed day, which will, of course, be on Wednesday?

BOB LANG: Well, let's remember what volatility is all about. Volatility simply rises when there's a lot of uncertainty in the markets, right? or the economy or anything like that. So when volatility has been coming down for the past four or five months, it means that the market is much more sanguine and much more certain that things are going to move in the right direction for the economy and for the market. So there's no reason to keep on protection.

And when people are buying put options in the markets and in other securities, they're basically buying protection against a large range of the market. So when volatility is down where it is right now, 14-13%, it's somewhat unprecedented, but it's not unusual to see that when uncertainty is being removed. And when is that uncertainty being removed?

Next week, we have two inflation reports, the CPI and the PPI. And of course, a lot of anxiety is going to be built up in front of that, and also the aforementioned Federal Reserve meeting that you've talked about. A lot of anticipation and anxiety is going to be built up in front of that. But once those events pass, Tuesday and Wednesday, I think it's back to business and starting to focus on the economy again.

JD DURKIN: Bob, you know what they say. It's not a party until you make at least one reference to the McClellan oscillator. Let's do that now. During Wednesday's show you noted one of the breadth indicators that you follow, of course, the McClellan oscillator, was nearing an overbought reading. Are we any closer to that red flag, or are we still in this kind of window of this period of window-dressing, as investors reposition ahead of next week's FOMC decision?

BOB LANG: Well, interestingly enough, JD, now, we had good, strong breadth the last time we met on Wednesday. And that was due to the strength in the Russell 2000. The S&P 500 was down sharply, almost a half a percent, and the NASDAQ was down almost 1% on Wednesday. But yesterday breadth was mediocre.

And why is that, it's because the Russell 2000 was responsible for that poor breadth reading. It was a down session for that index. So when you couple the two days together, Wednesday and Thursday, with rather negligible gains in the McClellan oscillator, so the McClellan oscillator is about, I'd say, slightly overbought right now. It's not to one of those wild, extreme levels that we could pretty much expect a drop in the markets just yet.

But I do think that a couple more up sessions, we could get a nice up session into the inflation readings next week. And then if that happens, we get a pullback in the markets when the oscillators get to an oversold reading. It's almost there right now.

JD DURKIN: So Bob, let's drill down a little bit more on those key inflation readings, because of course it is not just Fed week. We will get CPI and PPI. We broke down that fresh inflation data the Fed will be digesting, really coming out during the two-day meeting. While we wait to get CPI and PPI results I believe on Tuesday and Wednesday respectively, what are the Fed fund futures rates telling you?

BOB LANG: Well, Fed funds futures are going to be active over the next three to four sessions. And that's in front of the Fed meeting. Of course, we have the Fed meeting comes out. It's a 2-day meeting, Tuesday and Wednesday. Chair Powell will be speaking in a press conference at 2:30 about 30 minutes after the release of monetary policy decision.

But what's important here, JD, is in June, we get projections, projections from they call it the dot plot, of course, with projections from Fed governors and from economists and so forth. People on their staff are going to be putting data together to try and estimate what Fed funds futures are going to look like, unemployment, inflation, and GDP for the next three to four, maybe six quarters. So that will be an interesting data piece to take a look at on Wednesday afternoon.

But Fed funds futures right now are really only portraying about a 30% chance that the Fed is going to hike rates next week. And I think a lot of people are believing that the Fed is going to pause next week, and where July's meeting is probably more in play than next week.

JD DURKIN: So that is kind of the bet right now, right? It's as if you kind of have this pause for June and then maybe they resume in July, they start to cut later in the year? What is your sense and at least what does the market tell you?

BOB LANG: Well, I think we really have to pay attention to the data. And the Fed, and Chairman Powell has been very honest in saying that that's what they look at. They're waiting for the data to come out. And so next week, the Cleveland Fed, now casting inflation expectations, says that CPI is going to come in at about 2.4% month over month, on an annualized basis.

So that means that inflation is coming down to levels that are much more pleasing to the Fed. They're looking for 2% inflation or less. So the market seems to be driving this down, with, of course, we have had a lot of things that were issues with higher inflation. We had the bottlenecks with the supply chain issues and so forth, and elevated prices in commodities.

All those things are starting to help bring down inflation. So that's a positive for the Fed. And what's positive for the Fed means that they're going to start questioning whether they need high interest rates for longer down the road. So I think that the data next week, not just the CPI but the PPI, which came in with a negative number two months ago, if we get good readings on those, we're going to see the Fed start talking about pausing much more than just in June or maybe even July.

JD DURKIN: All right, so of course yesterday was Thursday. We got jobless claims, that saw 261,000 initial jobless claims, a number we've not seen, Bob, as you know, since 2021. How significant is that figure in your view?

BOB LANG: Well, that's an important data point, especially for the Fed, because the Fed is looking for a loosening up in the job labor market. And of course, they don't want to see people losing their jobs. But if jobless claims are starting to increase, it means that fewer jobs are available, and what's happening is that we're getting instead of a tight labor market, which is what we've had for the past couple of years, the labor market is starting to loosen up. And when that happens, we see inflation starting to come down, because average hourly earnings and wages start coming down, when the demand for workers starts to slow down. So I think that that is a good positive sign for the Fed in terms of Fed policy going forward.

JD DURKIN: Bob, it is certainly going to be a busy week. I am very grateful, as always, for the necessary context and perspective that you bring to me and to all of our members. Bob, have a great weekend. I appreciate you being here.

BOB LANG: Have a great weekend, JD, take care.

JD DURKIN: Absolutely. As a final programming note, members one and all, the Fed decision will not be the only thing to watch on Wednesday. That's right, join us live at 12:00 Eastern, of course, for our monthly members call. Chris Versace, as well as The Street's editor-in-chief Sarah Silverstein will be reviewing the entire portfolio.

So please, as always, send any and all questions to AAP club at TheStreet.com. Have a great weekend. We'll see you next week.