"Always borrow money from a pessimist, he doesn't expect to be paid back"
Author Unknown
Recent outperformance of small cap stocks over their large cap colleagues is starting to face an increased scrutiny. Not only today's article in WSJ raised some good questions about the increasingly suspicious rebound, but it also offered an explanation by raising the same point I have already raised numerous times over the last several weeks- the rally from July lows appears to have been driven predominately by short covering and not fundamental improvements in the underlying data...
So I think that a pair trade of short small cap ETF (like IWM)/ long (SPY) looks increasingly interesting... If markets turn down from here, small cap is likely to underperform; but on the upside the difference will probably be smaller and thus won't matter as much...
"Much of the fuel for small stocks is coming from the mass-reversal of bearish bets by hedge funds, many of them closing out their positions to lock in profits. And since small-cap stocks can be thinly traded, a rush of traders buying back stocks during the summer, when volume typically is light, is increasing the Russell 2000's move...
In the spring, nearly 11% of the shares of stocks in the Russell 2000 were sold short, Mr. DeSanctis says. That compared with just 2% for stocks in the Russell Top 200 index, where the average weighted market capitalization was about $107 billion as of July 31. In late June, short interest on a widely traded Barclays exchange-traded fund that tracks the Russell 2000 was nearly triple the number of shares outstanding, up from roughly even in January 2007"
And while I do not necessarily agree think that large cap stocks are going to be much safer during the upcoming quarter because of the negative US dollar impact on earnings of large multinationals, small caps have now simply ran too far too fast and thus are likelier to pull back in the short term...
On the other hand one needs to be carefully watching if mono line retailers like ARO,AEO, DBRN, PLCE, FINL, URBN,ROST, BKE, CRI and GPS continue their recent outperformance... In the past, this sector has frequently led the way out of a bear market...These are my favorites in the sector and are a part of my Bear Market Watch indicator- I use as a proxi confirmation of an major turn in the market's direction- many had a false start in the spring but look to be holding up better today- I don't think we are quite there yet for now, but the fact that most did well today is not a bad sign for stocks...
Here is an easy way to track these- courtesy of www.Stockcharts.com
http://stockcharts.com/charts/candleglance.php?ARO,AEO,DBRN,FINL,CRI,GPS,ROST,BKE,PLCE,NWY|B|A12,26,9
Do you have trend reversal indicator? Tell me what you think, leave a comment or send an e-mailskepticalcapitalist@gmail.com
