While I am not a " perma-bear" by any means, I must admit that
I've been perplexed by this unrelenting, "to the moon" bull
market, which hasn't really cooled off since it began over five
New highs are the norm now, with the market shrugging off bad
news and eating up any bit of good news. Nearly every index is
outperforming, many without so much as a small pullback here and
But notice that I said "nearly" -- one index group in
particular has recently cooled off, which makes me think that
others could follow suit by the end of this year.
I'm talking specifically about indices made up of stocks with
smaller market caps.
It's well known that small-cap stocks perform
better than their larger counterparts over time
, especially coming out of a recession, when growth is easier to
come by. However, when the market slows down and investors turn
to large-cap stocks for stability and dividends, small-caps are
the first to get snubbed.
Any downturn following that peak often sees small-caps getting
beaten up at close to the same rate they grew in the first
In the five years between when this bull market began in March
2009 and March of this year, the S&P 500 Index has delivered
a return of over 165% -- impressive by most anyone's standards.
However, compare that with the Russell 2000, a widely used
barometer for the U.S. market's smaller participants, which
posted a 222% gain in the same period.
What's giving me a reason to worry now is that the S&P 500
has continued to rise this quarter (to the tune of 3.7%), while
the Russell 2000 has pulled back about 7%.
What could be the cause for this decoupling?
Many are citing the extremely high valuations some of these
small-caps are stuck with now, given their meteoric rises in
stock price. Price-to-earnings (P/E) ratios have exceeded those
during the tech bubble days in some cases, sparking concerns that
a pullback is inevitable.
Large investors like hedge funds and other asset management
firms have been taking note. In April, these investors sold
$3 billion in futures contracts against the
, the largest amount relative to average levels since 2004,
according to Bloomberg and Bank of America.
Outflows from the
iShares Russell 2000 Index (NYSE:
are consistently registering large alerts week after week, while
some hedge funds are piling into puts on the exchange-traded
fund. For instance, billionaire Paul Singer of Elliott Associates
has disclosed a $424 million put position in IWM, with countless
other investment firms joining him in his views.
Risks to Consider:
Keep plain old volatility in mind. The weekly and monthly
peaks and troughs of small-cap indexes are much more jagged and
distinct than the smooth rise of the S&P 500, so larger
swings are to be expected.
Action to Take -->
While I'm usually an advocate of buying the dips, this disparity
between large-caps and small-caps might mean it's time to take
profits on some of your small-cap funds or investments,
particularly if they are trading at sky-high P/Es. Just as they
were the fastest to rise, they will likely be the fastest to fall
in a market turnaround.
© Copyright 2001-2010 StreetAuthority, LLC. All Rights Reserved.