The recent rotation out of smalls caps and in to financials in a broader context (the other way)

The narrow range of the past two weeks have been frustrating for just about everyone. The prior vertical run up had bulls wanting a pullback to add to positions and build support while the bears just wanted this parabolic bear market rally to end. I find myself in the latter camp but only barely so. It won't take much more upside for me to be convinced that this rally is for real and that we might be beginning a new bull market (that could last for years). Of course that's speaking from a strictly technical (chart based) perspective. Based on any fundamental metric, the notion of a bull market is criminal to me. But hey, I'm just here to read charts.


First we have the Russel 2000 ETF, IWM, over the past three months. Looks pretty bullish. I've pointed out golden crosses on other charts recently and the IWM has one too. After breaking past the key $53 mark IWM has been pretty much been range bound ($55-$58) . This flag-like pattern has served to work off overbought conditions but I'm not convinced. This whole move smells like a fake out (bull trap), where is the surge in volume that should have accompanied such a big breakout? Volume was declining until Friday's selloff which tested the bottom end of the recent range. I'd bet IWM retraces back to $53 where everybody will get there chance to vote with their wallets. Bulls will buy the pullback, Bears will try and run stops to force a failed move. The winner will draw in volume one way or the other...


The real meat of tonight's post is in the next chart. Lately I have noticed that the financials have really, really outperformed the rest of the market, especially the technology and small cap sectors. Don't ask me why this might be the case, the market behaves in seemingly naive and silly ways at times. But while big money has rotated from small caps into financials recently, the long term trend is a rotation the other way. Below I've got the financial sector ETF, XLF, divided by IWM. This is effectively a measure of financial sector valuation relative to the small cap sector:

So yeah, in the context of this three year trend (note the weekly time frame) the recent relative out performance of the financial sector is just a blip. For years now small caps have outperformed the financial sector by a wide margin and I don't see anything here to make me think that this trend is changing.

For a little more contrast on this issue I've got the ratio of Bank of America (BAC) to Apple (AAPL). Obviously, this ratio has gotten crushed by about 90% in the past three years despite having recently doubled. What I find most interesting about this chart is that you can see a roughly 5 month cycle in the sector rotation. That is, for about five months money moves from into banks like BAC, then for five months money moves into tech stocks like AAPL, then back to banks and so forth. In the end much more money has "rotated" into AAPL and so this ratio declined significantly.

To be honest I don't really know how much weight you can really put in these ratio charts but I have fun looking at them. If the five month cycle is true and if I'm right about the small caps pulling back here, then XLF should get hit pretty hard in the coming weeks.

Disclosure: I have puts on pretty much all this stuff including XLF, AAPL, QQQQ and IWM.

On an unrelated note, this weekend I was listening to an "oldies" radio station up in Chicago and they kept playing music from Woodstock mixed in with true oldies like Marvin Gaye and Roy Orbison. They were celebrating the 40th anniversary of Woodstock this weekend, which is great but come on, lets not start calling Classic Rock "oldies." No, I don't care how old I get, I will never call Santana, Joe Crocker, Jimi Hendrix or any of the other Woodstock acts "oldies." Hell no. What I will do, however, is join in with the "Oldies 94.5" in honoring this weekend's 40th anniversary of Woodstock with some Sunday night rock n roll. Enjoy: