The repeated underperformance of small-cap equities versus their large-cap counterparts is alarming. The Russell 2000 has been dramatically underperforming, as IWM (the ETF which replicates Russell 2000) has not been able to reclaim the net new high. This new high, at $120.64, was reached just after the March 7, 2014 U.S. employment report in the pre-market session. Since then IWM has been progressively deteriorating, especially when compared with SPY (S&P 500 ETF). This specific form of negative divergence, with small-caps underperforming large-caps, has characterized nearly all bear markets going back at least to the early 1900s, including the most recent bear market where IWM couldn’t surpass its early summer tops during October 2007.
Market fragility continues to increase as big “down” days are followed by decent “up” days, which is precisely how topping patterns and corrections play out.
VIX (volatility index) marked yet another higher low since it had completed a six-year bottom in March 2013. This confirms that the chance of a continued uptrend for general U.S. equities is sharply diminished. As is often the case, the first year or so of any U.S. equity bear market will be perceived as a “healthy” correction by the media pundits. Once the price fall accelerates, perhaps somewhere in 2015, then everybody will be caught off guard. The fact that almost no one is talking about negative divergences for U.S. equities is especially compelling since we had experienced similar complacency throughout the final seven months of 2007 and the first eight months of 2008.
Michael Gayed recently wrote an intelligent and alarming article in MarketWach: Understand the implications of the underperformance of the Russell 2000 vs. the S&P500
When we are transitioning from a bull market to a bear market for U.S. equity indices, as we have been doing for the past several months and will likely continue to do until some point in 2015, then it makes sense to be invested in assets which benefit the most from rising inflation. Historically, inflation almost always accelerates at this point in the economic cycle.