IS HIGH BETA ABOUT TO CRASH THE MARKET?

As stocks have become increasingly invulnerable over the last few weeks high beta assets have gone thru the roof.  The discrepancy between small caps and large caps has been particularly noticeable.  Since the February 8th bottom, large caps have rallied 12.5% while small caps have rallied 18%.  The divergence in performance has resulted in an unusual and potentially bearish scenario.  The ratio of large cap to small cap performance has plummeted in recent weeks to levels that have been seen just twice in the last 5 years.  At roughly 1.7, the ratio is reflecting the extremely bullish posture of most investors (just who isn’t bullish about 2010 besides Credit Suisse?).  This rare divergence between large and small stocks occurred in Summer of 2006 just before small caps declined 15% and then occurred again just weeks before the market crashed in October 2008.    While this doesn’t necessarily mean the market is about to tank it does imply that high beta assets have become unhinged when compared to their safer low beta counterparts.  Investors would be wise to take note.

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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Comments

  1. my simple take is that small cap will outperform large cap in a recovery until recovery matures, then large cap will outperform as recovery extends. fwiw, i think the market still sees the recovery from near death from LEH as benefiting small caps disproportionately for awhile

    it seems the mortgage insurers are reaching an inflection point turnaround, only for the speculators however.

    • This make no sense chris. Wasn’t the large caps that pulled everything up from the depths of LEH? Small caps tend to lead the speculative portion recovery and usually outrun itself. This rally is getting long in the tooth (possibly 1 – 1.5 more month(s) to go and about +3-5%). It is getting harder to make much money on the long side as the churning is insane which to me typified a huge distribution pattern. I am still buying deep ITM calls to make the 3-5% plus leverage but I think the good money is gone.

      • to your point, “Small caps tend to lead the speculative portion recovery”, i see the market as saying we are still in the speculative portion of recovery (which is fine by me)

        • True that we are still in the spec portion. I just think that we are in the beginning stage of the death of the cyclical bull rally. I expect at 1200-1220 a lot of longs only people who held through the crisis are gonna liquidate hard. If some of these people did cost average in, 1200-1220 is probably where most will break even. With most of the small time shorts as well as a lot of pro shorts demoralized from this rally, I expect a hard drop with an echo top to flush out the jumpy bears. Congrats on the long calls but this last 3-5% is gonna be a killer to gain unless you are disciplined.

          • It would seems a bit self-serving for these men to try to drum up business for equities. PIMPCO is probably trying to drive bond prices lower so he can profit again while Kelly and Bogle are trying to get J6Ps to trust equities again. After all without J6Ps dutifully allocating money away from bonds and into equities, these funds are not gonna make the nice management fees along with willing suckers to offload crap to.

  2. some low beta + high dividend yield are still there, let’s take vivendi for example.