The Small-Big/Domestic-International Disconnect
I tend to focus my attention on market internals through relative price ratio analysis to identify if certain consistent messages are occurring beneath the market’s surface. Intermarket analysis, which attempts to look within and across markets, requires analyzing not just a single sector or asset class, but several to see if investors are consciously or unconsciously sending messages through price movement.
This has certainly been a tumultuous year because of lingering fears over Europe, but despite the volatility, the S&P 500 as of writing has essentially gone no where (SPY, the S&P 500 ETF, is literally up about 0.08%). The Russell 2000 (IWM), however, for the year has fared worse, down about 5.9% and strongly underperforming. If you believe that markets here in the U.S. have been suffering because of economic concerns over the Eurozone, that spread differential should not make any sense.
Consider the following. From a market-cap perspective, small-cap stocks (IWM) tend to be more sensitive to the domestic economy than anything happening overseas. Intuitively this should make sense because globalization is driven by the biggest and most cash-rich companies in the world. In contrast, large-cap stocks (SPY) actually have quite a bit of exposure to overseas markets, with some estimates suggesting about half of the S&P 500′s revenue coming from outside the U.S.
Well wait a minute "“ if the volatility is being caused because of Eurozone recession/depression/implosion concerns, then why are large-cap companies which have so much exposure to revenue coming from overseas markets outperforming small-cap companies which are more sensitive to the U.S? Could it be that broad market averages are unjustified at these levels given conflicting messages from Europe, Emerging Markets, and U.S. small-cap stocks?
Small/Big (IWM/SPY) Price Ratio
Europe/U.S. (VEA/SPY) Price Ratio
Emerging/U.S. (EEM/SPY) Price Ratio
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Michael A. Gayed, CFA is Chief Investment Strategist at Pension Partners, where he structures portfolios. Prior to this role, Michael served as a Portfolio Manager for a large international investment group, trading long/short investment ideas in an effort to capture excess returns. In 2007, he launched his own long/short hedge fund, using various trading strategies focused on taking advantage of stock market anomalies. Michael earned his B.S. from New York University, and is a CFA Charterholder.
Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data, ability to repeat discredited memes, and lack of respect for scientific knowledge. Also, be sure to create straw men and argue against things I have neither said nor even implied. Any irrelevancies you can mention will also be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.
[...] thoughts from a Guest Author over at the Big Picture. I have noted several times that exchange rate arbitrage is where most S&P earnings are [...]
I would draw the arrows differently. Market disovers that:
Europe economy is weak; from Sept 09 Emerging economy is weak; from Oct 10 Domestic economy is weak; from April 11
” Well wait a minute "“ if the volatility is being caused because of Eurozone recession/depression/implosion concerns, then why are large-cap companies which have so much exposure to revenue coming from overseas markets outperforming small-cap companies which are more sensitive to the U.S? ”
Investors may be assuming that big corporations have a better chance of surviving a large shock.
It worked great in the banking sector.
It’s their “too big to fail” premium. That, or their dividends. :D
If you think stock prices are forward-looking, maybe it suggests expectations of different conditions in the future than exist right now, which might justify the apparent disconnect.
As someone involved in a couple of small-to-mid-sized companies, one issue smaller companies face is access to capital on attractive terms. Credit markets are very unattractive right now, especially for smaller firms, reflecting a general “flight to safety” approach by capital everywhere.
“…Could it be that broad market averages are unjustified at these levels given conflicting messages from Europe, Emerging Markets, and U.S. small-cap stocks?”
…or that having small cap ETFs in your portfolio isn’t going to look to well to the fund partners?
I think, the latter.
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"Advice is what we ask for when we already know the answer but wish we didn't." -Erica Jong
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