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Michael Gayed: Why Large Caps Could Collapse

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Markets are driven by psychology and behavior. As a result, large caps could suffer, regardless of the fundamentals.

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Every wave, regardless of how high and forceful it crests, must eventually collapse within itself.
-Stefan Zweig

Contrary to popular belief, markets are not driven by fundamentals.

They're also not driven by technicals. 

Markets are driven by psychology and behavior. 

And one of the most persistent investor behaviors may topple the large-cap S&P 500 Index (SPX), which has been the market leader in 2014 relative to the small-cap Russell 2000 (RUT).

The Russell has performed poorly on the realization that global growth is slowing.

In behavioral finance, there is a phenomena called the disposition effect. Studies show that most traders and investors tend to sell their winners before selling their losers. People don't want to realize losses -- they want to at least break even. So when things get tough and liquidity needs to be raised, studies show that  profitable positions get the most selling pressure. 

The disposition effect was one of the reasons I argued in September 2011 that Gold (GLD) was about to collapse. In the midst of the 2011 Summer Crash, it was the last risk asset winner standing.

Large-cap stocks now have that dubious honor. Defensive sectors within the space, which our equity sector ATAC Beta Rotation Fund (BROTX) has positioned all-in on recently, show leadership. Investable markets worldwide are suffering rom the Fall Epiphany of 2014 that growth and inflation expectations completely disagree with where we are in the cycle and what stocks have priced in. 

Large-caps have been the last basket standing clinging on to gains, while small-caps have been eviscerated. 

Take a look below at the price ratio of iShares MSCI USA Momentum Factor ETF (MTUM) relative to the SPDR S&P 500 (SPY). 


Click to enlarge

As a reminder, a rising price ratio means the MTUM (the numerator) is outperforming (up more/down less) than the SPY (the denominator).  A falling ratio means the opposite. The far right section of the chart suggests momentum may be about to turn downward.

Large-caps have been the last source of momentum, which means they are likely the only area which has gains in 2014.  If momentum is about to falter because the disposition effect kicks in, we could see meaningful decline in large cap averages, causing a negative feedback loop which results in even more selling and lower prices ahead.

You know what they say about the one fact pertaining to all conditions, right?

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This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

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No positions in stocks mentioned.

This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

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