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Small-Caps Warning to Nouveaux Bulls

Stocks in this article: IWM SPY

History is a vast early warning system. -- Norman Cousins

NEW YORK ( TheStreet) -- Over the past three weeks I have been making the case in my writings and various media appearances that market internals were suggesting the odds of a correction were rising despite the focus on Dow 14,000.

European markets have clearly been wobbly, China suddenly appears to be tightening liquidity and bond yields are not convincingly rising above key resistance levels.

The Nouveaux Bulls who are under the assumption that stocks can not fall because of the "Bernanke Put" fail to remember there were two corrections in 2012 despite it being the best year for equity averages since 2009 in the U.S.

This is not about opinion. What I think and what you think does not matter. What matters is what the person you're selling to thinks, because that is the person who sets price.

There are a large number of reasons on the macro front to be concerned in the near term ranging from the upcoming Italian elections to the U.S. sequestration. Clearly growth domestically has been more potent than overseas, which has helped to cause our markets to do relatively well. However, I question whether this sentiment is about to change.

Take a look below at the price ratio of the iShares Russell 2000 Index (IWM) relative to the SPDR S&P 500 (SPY). As a reminder, a rising price ratio means the numerator/IWM is outperforming (up more/down less) the denominator/SPY.

Small-cap stocks by their nature tend to be much more sensitive to domestic growth than global growth. As such, when high beta small-cap stocks underperform, it signals bets on a slowdown in domestic activity relative to global pickup. We know clearly that the cyclical trade globally is under attack given the breakdown in commodities and poor performance in emerging markets.

Note that the trend in strength of high beta small-caps appears to be waning, and may soon turn down.

The implication? Sentiment may be souring on the U.S., just as gas prices continue their rise and the payroll tax holiday expiration gets felt. The consumer may be in trouble, and so too then would be the Nouveaux Bulls.

At the time of publication the author had no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

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