Another trend that requires vigilance is the desire (or lack thereof) for small-cap stocks. The “James Bullard bounce” that began on October 16 helped small-caps as much as any asset class. Yet suggesting that one’s Federal Reserve colleagues keep the quantitative easing door open is not the same as lowering rates or buying more bonds with electronically created dollars. It remains to be seen if small-caps will once again weaken, roll over and create consternation in the minds of carry traders and institutional money managers.
One method for staying abreast of small-cap stock direction? Watch for a technical break-out in iShares Russell 2000 (IWM). If it cannot surpass the levels that it reached in March and July of this year, one would have to question the resilience of the small cap space. It is also worth noting that the Relative Strength Index (RSI) reading for IWM bumped up against 70 in March and July, then proceeded to sell off in dramatic fashion. At present, IWM is bumping up against an RSI of 70 once again.
In the previous decade, stock market success corresponded to a weak U.S. dollar. One of the big reasons? Roughly one-third of S&P 500 corporate profits came from overseas. The appreciation in foreign currencies helped to supercharge earnings. Today, 40% to 50% of S&P 500 profits may be attributable to faster-growing emerging markets as well as developed foreign economies. The implication? The surge in the dollar adversely affects both U.S. exports as well as the overseas component of corporate earnings.
What might you watch for? Take a look at the price ratio for Vanguard FTSE All World ex U.S. (VEU) with the never-say-die SPDR S&P 500 Trust (SPY). If VEU:SPY stabilizes or rises, one would have to feel better about the U.S. bull market’s prospects. If VEU:SPY continues to deteriorate, however, I would expect the U.S. bull market to falter.
