- Oversold bounce in small-caps may continue.
- Unprecedented behavior underappreciated by market participants.
- Fragile 5 proof of non-crisis.
"Two roads diverged in a wood, and I - I took the one less traveled by, And that has made all the difference." - Robert Frost
Large-cap stocks (NYSEARCA:SPY) closed at new highs last week as beaten down small-caps continued to fight off of deeply oversold levels. The about face behavior in Utilities the last couple of weeks seemed to have been anticipating some near-term improvement in equities, while Treasuries (NYSEARCA:TLT) continue to remain unconvinced about the current state of the economy. FOMC minutes were released, and much like a Pavlovian dog that salivates at the sound of a bell, predictably resulted in continued excitement for low rates for longer. Why this is ever a surprise to anyone is beyond me - markets move on news which is no longer new, but rather an established historical fact.
In last week's manager call, I noted to advisors that there is a real lack of appreciation for just how bizarre this market environment has been. Behaviorally, everything except large-caps and emerging markets have acted like a correction already took place. Small-caps (NYSEARCA:IWM) suffered an alpha crash, momentum names got clobbered, and everyone hid out in low beta sectors. Meanwhile, headlines about the Dow (NYSEARCA:DIA) and S&P 500 have masked what was true and severe deterioration within the market.
At a recent Market Technicians Association presentation, a well known and respected technician made the point that the Summer is likely going to be a difficult one for investors given where we are in the presidential cycle and the stealth correction in small-caps names. It is hard to disagree. There are many similarities to 2011 in the way sector leadership has played out thus far, with the exception of Energy and Materials leading. Certainly disconnects within the market have been stark. It has been noted that it is beyond abnormal to see the VIX near record lows at the same time the Russell 2000 is under its 200 day moving average. How long such divergences can occur is unclear, but it is worth thinking about. We are at an important fork in the road where something has to give, and soon.
Our ATAC models used for managing our absolute return and equity sector rotation funds and separate accounts remain positive on conditions which favor equities overall, with a considerably higher tilt towards global sensitivity. Elections in India have reminded the world that political change can be more powerful than QE, as everyone seems to have forgotten the term "fragile five." I have said this before and it is worth repeating: if everyone is calling something a crisis, it either already happened, or never will. The emerging market crisis narrative is on its way to being proven a work of fiction. Momentum is picking up, and should it stick, the time may finally be here for a substantial and uncorrelated move higher relative to US markets. The ultimate way of throwing everyone off in the months ahead? A rising VIX, and honey badger emerging market move correlated in the same direction.
Stranger things have happened - you know, like US stocks pricing in reflation which doesn't exist, a fragile five non-crisis, a non-rising rate environment...
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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