Making a Sector Bet Via the Russells
One of the sales pitches for alternative investments is that they do not rely on a bull market to generate gains. Many strategies, such as long-short, convertible arbitrage and market-neutral, are designed to exploit opportunities derived from the convergence of related assets.
Spread trades are staples in the worlds of futures and options. The rules for long and short positions are symmetric for futures, as they must be if the instruments are to serve their purposes of price discovery and risk management, but they are asymmetric for stocks. A spread involves taking a short position, and this is considered un-American in many quarters. After all, who ever heard of a downtick rule for buying stocks, and can anyone tell me what the circuit breakers are for shutting down the market during a big rally?
If investment gains going forward are going to be tough to realize as some people believe, it may be time for all of us to start trading like a hedge fund. This means working to achieve specific returns through specific trading opportunities and not relying on a bull's tailwind to push you forward. Can we exploit the spread between large-capitalization stocks as represented by the Russell 1000 (RIY) and small-capitalization stocks as represented by the Russell 2000 (RTY) as one of these strategies?
The Russell indices are used here instead of, say, the spread between the S&P 500 and the Nasdaq 100 because there is no overlap between the two indices. The Nasdaq 100 accounts for 13.37% of the S&P 500's weight.Over the course of time, the spread between the Russell 1000 and Russell 2000 has exhibited some long and persistent trends punctuated by some gut-wrenching short-term reversals. The reversals usually represent singular events such as the October 1987 crash or "Microsoft Monday" in 2000. The trend since early 1999, highlighted with a channel line, has been for the Russell 2000 to outperform. We have to look behind the gross numbers and into the sector detail to see why this may be happening.
|A Trending Spread
|Russell 1000 Sector Distribution
|Russell 2000 Sector Distribution
Tracking the DifferencesWhere are the biggest differences in the sector distribution of the two indices? The Russell 1000 is weighted more in diversified financial services, miscellaneous (yes, that's an actual sector name), manufacturing, oil and gas, pharmaceuticals and telecommunications. The Russell 2000 is weighted more in REITs, commercial services, Internets, electronics, gas utilities, banks and savings and loans.
|Russell 1000 vs. Russell 2000
Comparing the sector distributions of the two indices
Select the service that is right for you!COMPARE ALL SERVICES
Jim Cramer and Stephanie Link actively manage a real portfolio and reveal their money management tactics while giving advanced notice before every trade.
- $2.5+ million portfolio
- Large-cap and dividend focus
- Intraday trade alerts from Cramer
- Weekly roundups
Access the tool that DOMINATES the Russell 2000 and the S&P 500.
- Buy, hold, or sell recommendations for over 4,300 stocks
- Unlimited research reports on your favorite stocks
- A custom stock screener
- Upgrade/downgrade alerts
Jim Cramer's protege, David Peltier, identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.
- Diversified model portfolio of dividend stocks
- Alerts when market news affect the portfolio
- Bi-weekly updates with exact steps to take - BUY, HOLD, SELL
All of Real Money, plus 15 more of Wall Street's sharpest minds delivering actionable trading ideas, a comprehensive look at the market, and fundamental and technical analysis.
- Real Money + Doug Kass + 15 more Wall Street Pros
- Intraday commentary & news
- Ultra-actionable trading ideas
Our options trading pros provide daily market commentary and over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.
- 100+ monthly options trading ideas
- Actionable options commentary & news
- Real-time trading community
- Options TV