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To help visualize key aspects of the commentaries posted on this blog recently, the accompanying 2 charts illustrate important patterns that investors should keep a close watch on.

The first chart* covers the price action since the early March lows of this year for the three major US style categories – Mid (NYSEARCA:MDY), Small (NYSEARCA:IJR), and Micro (NYSEARCA:IWC)cap – and perhaps the single most important non US market, China (NYSEARCA:FXI). What is quite clear is that the higher risk categories have outperformed the lower risk, larger cap group S&P 500 – SPX) by a considerable margin. This is what is known in many circles as the beta trade: higher beta = better performance.

The second chart shows the beta trade continuing over the past three months, but not for all indices tracked. The beginnings of a meaningful divergence appears to be underway with China as price performance has begun to trail the four predominantly US indices.

Investment Strategy Implications

What you want to keep your eye on is any more substantial divergences between the big boys (SPX) and their lower quality/higher risk brethren and various global markets. As noted in last week’s commentaries, I expect such divergences to begin to emerge as earnings seasons unfolds and reveals an underwhelming performance by the higher risk US companies (represented by MDY, IJR, and IWC).

The wild card is the other index listed – China. I am in the camp that is more than a touch reluctant to drink the “China is great, no problem here” Kool-aid – a fact that the price action of the index may reveal in the coming months.

*click images to enlarge

Source: Divergences on the Horizon