NEW YORK (TheStreet) -- Stocks may be reaching support levels after heavy selling pressure the past few weeks.
In order to determine support levels of stocks, consider a relative strength indicator, in this case iShares Russell 2000 (IWM) over iShares 20+ Year Treasury Bond (ETF) (TLT), which measures small-cap stocks in relation to long-dated Treasury bonds.
Small-cap stocks tend to lead the market when investor confidence is strong, while Treasuries lead during times of investor anxiety. Overall, the back testing of this indicator shows that it does correlate well with movements in U.S. equities.
Shares in the iShares Russell 2000 were recently up 78 cents to $110.29. Their 52-week high was $117.37 hit last month, and the low was $88.79 last February. Shares in iShares 20+ Year Treasury Bond were recently up 49 cents to $101.19. They have traded in a 52-week range between a high of $124.26 and low of $101.17.
Over the past year, driven in part by the Federal Reserve's stimulus program, equity markets across the globe have trended higher.
There was so much liquidity running through the system that investors knew any attempt to sell off would be met by resistance from the Fed. That deterred bears from selling assets short and kept the iPath S&P 500 VIX ST Futures ETN (VXX) -- a measure of market anxiety -- at record lows.
Nonetheless, analysts knew buyers had to sell assets at some point. U.S. equity markets were reaching all-time highs without the slightest bit of selling pressure. That kept some buyers who missed rallies out of the market for fear of chasing stocks higher and ultimately buying as the market topped.
Now that the Fed has begun to reduce its stimulus program, however, bears have reemerged from hiding.
Since the beginning of the year, the Vanguard Total World Stock Index ETF (VT) has corrected lower more than 6%, indicating a global equity selloff. That has come alongside an 8% move higher in iShares 20+ Year Treasury Bond (ETF).
Many have questioned how Treasuries could move higher as the Fed actively attempts to tighten monetary policy. The answer is that bonds have been bid higher out of fear. With emerging-market assets selling off and equity markets correcting lower, Treasuries are one of the more attractive assets across the globe.
The equity selloff has been strong, but many investors on the sidelines see it as a great opportunity to buy at cheaper valuations. The markets' move higher last year left many stocks overvalued by traditional measures.
With prices now beginning to stabilize, the selloff could become a catalyst for investors to reenter the market and push equity prices to new highs.
Looking at the indicator below of small caps over Treasury bonds, it looks as if the pair is approaching support levels last seen in September.
As investors begin to find value, small-cap stocks may begin to lead the market higher. And because Treasuries appear to be overvalued, the index could sell off if the Fed continues to cut stimulus. That could lead to a profitable pair trade this year -- selling Treasury bonds and purchasing small-cap equities.
At the time of publication, the author had no position in any of the funds mentioned.
This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.