click on images for larger view
It’s hard to make the large cap argument out of yesterday’s liquidity driven rally by the momentum lemmings. As the one-day chart of the size indices above show (first chart), the Small and Micro styles did best, while the Mid caps held their own. There are two thoughts that come out of yesterday’s hoopla.
To begin, one day does not a trend make. The recent relative performance weakness in the Smids since the S&P 500 made its high on July 19th has produced a non-confirmation similar to what the Dow Theory is now indicating (see second and third charts above). The problem with making too strong of a case for the non-confirm call is the fact that (a) only the gap between the Dow Transports high and current price is wide enough to seriously suggest that the current non-confirmation will hold* and (b) global markets range from acceptable (Japan) to strong (EAFE) to white hot (emerging markets). And that takes us right back to the Fed and excess liquidity, which is the second point.
From an equity market's perspective, yesterday’s run to new highs makes clear the folly of the Bernanke Fed’s rate cut decision as the liquidity game is (mostly) back on and, with it, is the return of the momentum lemming trade. With money still very, very abundant and the pressure to perform always on maximum, the momentum lemmings have no choice but to stampede in when the markets are hot, tending to make them even hotter and, thereby, making excess the rule of the investment land.
Investment Strategy Implications
When the Fed signaled that it was abandoning its liquidity draining effects with the speculative guess that the US economy might be headed for a recession and, therefore, reinstituted the principles of the Greenspan era – preemption and the moral hazard risks of the Greenspan put – it, to a large extent, turned back the clock to the liquidity game that had reached excessive levels. And, in doing so, unleashed the momentum lemmings to reassert their liquidity game. (Or what Morgan Stanley's former chief investment strategist, Henry McVie, called the "Misalignment Triangle".)
There are, however, chinks in the bullish armor that bear noting and I stand by my concerns re this month (see yesterday’s blog excerpts and report) and would lighten equity holdings into this rally. After all, it’s still a bull market ‘til it ain’t. And I am a buy low, sell high type of guy (the antithesis of the momentum lemming). What yesterday’s action suggests is a return of the kind of bull market the momentum lemmings know and love. And with it the return of liquidity-driven speculation.
*However, that was also the case in late 2006, only to have the Transports stage a powerful rally into early 2007 and confirm the highs. In other words, Dow Theory seems to work only if other indices are also not confirming the highs made by the Dow Industrials.
The fundamental justification supporting this technical approach to market predictions is the signal that other segments of the economy are sending via their stock representatives. In other words, if the Transports are not confirming the Industrials new highs, it is signaling that economic conditions of the companies that comprise the Transports index are experiencing earnings growth or other fundamentally oriented difficulties.