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Russell 2000: Small-Cap Stocks Rally—New Market Highs Ahead?

Wednesday, 10 Jul 2013 | 6:00 AM ET
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The string of new highs hit by the small-cap Russell 2000 index may be a bullish sign for the stock market, according to market strategists.

The Russell 2000 index, which is most sensitive to domestic growth expectations, is closed at a record high for the third-consecutive session. The index finished above the 1,000-level for the first time last Friday, after several unsuccessful attempts to break that level over the last few months.

"It's bullish that the Russell 2000 has reversed its downtrend off the May 22 highs and breaking out to new highs," said Craig Johnson, technical market strategist and managing director at Piper Jaffray. "And when we get an index as broad as the Russell 2000 breaking out to new highs, that suggests that the internals of the market is very strong and we have a lot of stocks that are participating in this move."

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For the year, the Russell 2000 has soared nearly 20 percent, outpacing the S&P 500's 16-percent rally. Small-cap leadership is usually considered a bullish sign for the overall market, according to market professionals, as the sector is considered a good gauge to judge economic health on a domestic level.

"This move above 1,000 is certainly encouraging, but the thing that's most intriguing is how the stock market has come to grips with a higher interest rate environment," said Todd Salamone, the director of research at Schaeffer's Investment Research. "Investors are looking at it as something the economy can handle and that it's a bullish sign for the economy."

The yield on the 10-year note has gained a full percentage point since hitting its bottom of 1.62 percent in early May. And within that period, the Russell 2000 spiked nearly 8.3 percent, widely outperforming the S&P 500's gain of 3.4 percent. Analysts say the small-cap index's outperformance can be attributed to investors favoring companies that mainly do business in the U.S., over those that conduct business overseas.

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"It's also a sign that there's more people are more willing to take risk," said Salamone. "And right now, another reason you're seeing this massive small-cap outperformance is because with bond yields moving higher, [small caps] have become more competitive versus stocks that pay dividends. So you're seeing a rotation out of high-dividend stocks as investors seek higher returns via capital gains and higher beta type names such as the small cap."

As a result, strategists believe other major averages have further upside ahead.

"I do suspect you'll see the other major averages follow suit and also make new all-time highs…there's still more room to run this year," according to Johnson. "We reiterate our price objectives for the S&P 500 established in August of 2012 as follows: a 12-month price objective of 1,700 and a 24-month price objective of 2,000."

Meanwhile, Salamone pointed out that "round numbers" could be a challenging area for indexes. For example, he noted the last time the S&P 400 midcap index similarly hit its benchmark 1,000 mark for the first time in April 2011; it took nearly two years for the index to make a sustainable move above the level.

"Still, from a sentiment perspective, we're in a much better backdrop now."

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—By CNBC's JeeYeon Park (Follow JeeYeon on Twitter: @JeeYeonParkCNBC)

Questions? Comments? Email us at marketinsider@cnbc.com

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    Patti Domm is CNBC Executive Editor, News, responsible for news coverage of the markets and economy.

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