A US Stocks Correction and an Emerging Market Rally?
We may be in a euphoria stage for US equities, which might lead to mean reversion from emerging markets, and a correction could take place.
-- Ralph Waldo Emerson
With the stock market in the US at new all-time highs and what feels like a return to the 1990s, many are unsure how to position. After such an extreme move, Gray-Haired Bears are making the case that we are in a blow-off extreme environment, especially when looking at the Russell 2000 (NYSEARCA:IWM), which is about 15% away from its 200-day moving average. However, more and more Nouveaux Bulls seem to be piling in, re-allocating away from laggards with the hope of trying to squeeze out some more gains from the uptrend.
To some extent, I do believe that the US is now a crowded trade. Reflation hope still seems to be unfounded, and optimism by the Fed may ultimately prove unwarranted. Mean reversion is one of the most tried and true phenomena in the business of investing, and it does seem plausible that strength in emerging markets could coincide with a faltering US market to close the gap between the two. I have often referred to emerging markets (NYSEARCA:EEM) as the “next fat pitch” upon enough confirmation of rotational leadership. But could they lead with the Dow Jones Industrial Average (INDEXDJX:.DJI) falling?
This seems very plausible. Defensive areas of the stock market got to extreme oversold levels from an intermarket trend standpoint. Take a look below at the price ratio of the Consumer Staples Select Sector SPDR ETF (NYSEARCA:XLP) relative to the Consumer Discretionary Select Sector SPDR ETF (NYSEARCA:XLY). As a reminder, a rising price ratio means the numerator/XLP is outperforming (up more/down less) the denominator/XLY.
I have often referred to this as the “need/want” indicator for the consumer. When low-beta, high-dividend consumer staples stocks outperform higher-beta consumer discretionary stocks, it tends to precede deflationary pulses, higher correlations, corrections, and volatility. Strength earlier in 2013 has been a notable exception given disconnects that began late January in various intermarket trends. Note the extreme move in the last few weeks in the ratio.
Indeed the trend is still down, but the sharpness of the move might mean we are in a bit of a euphoria stage. Higher rates may start to serve as a drag on the consumer, and from a contrarian standpoint, few are willing to make a negative call on the US. Combined with price action, that may be exactly why a correction may be right around the corner. My firm's ATAC (Accelerated Time and Capital) models used for managing our mutual fund and separate accounts favor bonds at the present time. Leadership in consumer staples would serve as more evidence to be careful out there.
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