Small Caps and Contrary Indicators?

The market continues to show impressive resilience, despite rather overbought conditions, and significant overhead resistance. It is apparent that buyers are below – pullbacks have been shallow, the market’s internals remain firm, and the general tenor of the action is healthy. That said, we continue our practice of bringing to your attention issues that bear watching going forward:

SMALL CAP RALLY The only Green yesterday (see above) was the Russell 2000. Small caps have been hot Hot HOT!, with many hitting new 52 week highs. This suggests that a speculative fervor has returned in force, with “panic buying” occurring in many of the above names. This can at times be a warning sign of an impending short-term blow off top.

BOND RALLY With interest rates at 45 year lows – that’s 1958 for the math impaired – there is an audible clamor of investors piling into Treasuries; Our Bond desk believes the fixed income market is a screaming sell right here; Bond funds continue to suck up loose cash, while the equity markets are enjoying only modest inflows. According to AMG Data, for the week ending May 7, equity fund inflows were $1.1Bil, while bond fund inflows were more than 3 times that amount – $3.4B. This is definitely a continued concern for the equity market, and yet another thing to keep an eye on going forward.

Contrary Indicators abound; Several broad factors which often coincide with Market bottoms are present:

As mentioned previously, the financial press has been in a severe retrenchment. Beyond the gutting of CNNfn and the ratings drop off in CNBC, a trio of high profile financial magazines have closed recently; This is noteworthy, if for no other reason than as potential contrary indicators. Mutual Funds Magazine, Bloomberg Personal Finance, and now Worth reflect Main Street’s newfound lack of interest in Wall Street – a necessary component of a bottom.

Also on the Contrary Indicator list is the recent Morningstar new fund category classifications; Noteworthy is the new category for “Bear Funds.” It strikes us as rather late to the party after a 75% drop in the Nasdaq, to just now be opening Bear Funds, or establishing a category for this group. Just as the scramble to roll out new Internet funds in 1999 and 2000 was topping sign in that sector, the belated rush to Bear Funds could very well be a positive, long-term signal that the bottoming process is further along than many realize.

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Quote: “As long as the reason of man continues fallible, and he is at liberty to exercise it, different opinions will be formed.” –James Madison, The Federalist, No. 10

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