Here at The FRED Report (
), we believe that the early July low is significant, and may ultimately turn out to be the low for 2010. If this is the case, what areas of the market will lead in the months ahead?
Right now, leadership is murky, with many comments from prominent managers and analysts. Bill Miller at Legg Mason suggests large cap stocks will lead and Rich Bernstein, formerly of Merrill Lynch (and my old boss!) suggests that small caps will be big winners. Both of these arguments are based primarily on valuation, while we tend to look at things from a technical perspective. We discussed this today on our weekly conference call. Feel free to listen to the playback:
We have to come down in favor of the small cap and mid cap corner. The reason is that the small and mid cap indexes have made higher lows than the February 2010 correction lows, while the larger cap indexes exceeded those lows. Let's look at some examples. First, we look at the chart of the iShares Russell 2000 Index Fund (IWM). This ETF represents the Russell 2000 Index (^RUT) and is making higher lows. This ETF is focused on small and mid cap names.
We note that the iShares Trust S&P Small Cap (IJR) (flash crash lows notwithstanding) has made a higher low, and this ETF is made up of small cap names only. The IJR suggests that smaller stocks are outperforming mid cap names.
Turning to large cap ETF's, we see that the SPDR S&P 500 ETF (SPY) has exceeded the February 2010 low, but that the iShares S&P 100 Index ETF (OEF) has been weaker. The OEF represents the S&P 100 (^OEX) -- the 100 largest cap names in the SPY. We can see from this cursory analysis, that the smaller the capitalization, the less the market took the ETF out to the woodshed.
As technicians and traders, we tend to buy strength and not weakness. Our fundamental justification for this is that smaller names tend to outperform after a recession and this outperformance can last for several years (for more detailed analysis of this, please read our Monthly Report:
At a minimum, we believe investors should maintain a liberal allocation to small and mid cap names.
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