When The Soldiers Fall, How Soon Before The Generals Surrender?

One of the more interesting stories from last week is the extent of outflows (redemptions) currently being experienced at key exchange-traded funds (aka ETF's) like the Russell 2000 iShares (symbol IWM). This is the largest of the small-cap ETF's with $23.6 billion under management where outflows totaled $2.2 billion, or 8.6%, last week. The smaller leveraged cousin ProShares Ultra Russell 2000 actually lost an incredible 41.4% of its assets under management last week. While outflows in the largest ETF of them all, the SPDR S&P 500, weren't nearly as significant on a percentage basis (-1.77%), the total redemption (outflow) in the SPY ETF was still noteworthy at $2.8 billion last week. 

The Russell 2000 Index closed below its 200-day moving average line last week, and most technical analysts are all asking the same question. Will the small-cap stocks rebound or will large-cap stocks soon turn down to match the losses sustained recently in small-cap stocks? My best guess is reflected in my current position which is effectively a leveraged bearish short in the S&P 500 Index (using the SDS ETF). 

The Russell 2000 Index peaked on March 4th, 2014 at 1,212.80. It then fell almost exactly 10% to an intra-day low at 1,091.50 this past Friday, May 9th before bouncing about 1%. If the 5-year bull market in U.S. stocks is still alive, then small-cap and battered momentum stocks will rebound sharply in the days and weeks ahead, and the larger stocks will probably tread water or trend slightly higher. If a major correction is now underway, as I believe is the case, then the large-cap "generals" will soon fall sharply to join the small-cap "soldiers" in full retreat.

Russell 2000 Index Daily Chart with 200-Day Moving Average Line

Russell 2000 Index Weekly Chart with 20-Week & 40-Week Moving Average Lines

P.S. In my February 16th, 2014 column I wrote the following: "Gold/Silver mining stocks are probably "fairly valued" now and should therefore be scaled back or completely liquidated in most portfolios." Gold/Silver mining shares had rallied between 30% and 100% from their December 2013 lows to their February peaks, and my recommendation in mid-February was to take profits and wait for the next great opportunity in this volatile sector. While my computer system has yet to trigger any meaningful "buy" signals here, on Friday, May 9th I purchased several Gold/Silver mining shares for the first time since February. My allocation to this sector went from 0% to 14% this past Friday. While 14% may seem high, my allocation to this sector peaked at 40% in late December 2013. Right now, I like Silver more than Gold, but if one rallies then both will probably rally. And if/when the Silver ETF (symbol SLV) advances above it long-term downtrend line at $20/share, then upside potential for silver mining shares looks explosive. In the interest of full disclosure, I am now long First Majestic Silver (AG), Endeavour Silver (EXK), and Primero Mining Corp (PPP) in my largest managed account.

 

U.S. Stock Market - Record High, But NYSE Margin Debt Declines

The Dow Jones Industrial Average posted a new all-time closing high on Wednesday of last week (just barely), but the intra-day record high for the DJIA, as posted in early April, was never violated. Except for the New York Composite Index, no other major index saw record highs last week on either basis, intra-day or closing. In fact, the Russell 2000 Index is still about 7% below its record high as posted on March 4.

For the bearish camp, the recent rotation out of small-cap stocks into large-cap stocks has probably been frustrating. However, the really great bull markets almost always end with one last rotation into the so-called "blue chip" large-cap names. 

How are we to know when this dance is really done? I wish I could write that there was a magic formula and that I had it! Unfortunately, there is no magic formula, just a trail of bread crumbs that may show the way.

I've attached two charts here that may suggest that the music has already stopped. Weekly chart sell signals were triggered by my computer trading system at Friday's close in the blue chip drug giant Johnson & Johnson (JNJ) and also in the Dow Jones Utility Average.

Johnson & Johnson Weekly Bar Chart with Computer-generated Buy & Sell Signals

Dow Jones Utility Average with Computer-generated Buy & Sell Signals

It may be worth noting that NYSE Margin Debt exploded in recent months to a record high $465.72 billion as reported at the end of February 2014. Equally important is the fact that Margin Debt had expanded for eight straight months between July 2013 and February 2014 before finally contracting in March (the latest reporting period) by $15.44 billion to $450.28 billion. Movements in NYSE Margin Debt as plotted against the S&P 500 Index show a 96% correlation coefficient. I believe it was the great Stan Weinstein (author of The Professional Tape Reader) who once said that expanding Margin Debt is bullish for stocks (even at record levels), while contracting Margin Debt is bearish. This first significant monthly downtick for Margin Debt in March (as reported by the NYSE last week) may actually represent another important clue that the bull market in U.S. stocks is over!

Also, a daily chart sell signal was triggered on Friday in the Dow Jones Industrial Average ETF, better known as the Dow Diamonds (symbol DIA). 

In the interest of full disclosure, I currently hold a significant position in the double-short S&P 500 ETF, symbol SDS, in one of my managed accounts.

Dow Jones Industrial Average ETF (DJIA Diamonds DIA) Daily Bar Chart