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Market divergence: Dow hits new highs, but small caps still struggling

Philip Pearlman
Philip Pearlman

Everyone in the world is now focusing on the extreme equity market divergences. They cause a good bit of anxiety and appear striking to observers forever looking for patterns in the big scheme with which to make sense of the universe.

First, there’s the difference in performance between the large caps and the small caps. The large cap Dow Jones Industrial Average is making new all-time highs while the small cap Russell 2000 closed below its 200 day moving average last Friday.

Related: Small caps slammed! Tension builds on Wall Street

Second, the number of NYSE stocks making new highs minus the number of NYSE stocks making new lows continues to look mediocre at best even as the Dow and S&P make all time highs.

Something has to give one way or the other. Either small cap under-performance and the relatively poor market internals drag down large caps or the small caps battle back and play catch up.

The million dollar questions go like this -

Is this a healthy washout where small cap stocks and 2013’s momentum darlings, which furiously sprinted higher for months on end, get knocked down a peg in a healthy corrective manner before the broader bull market resumes?

Or -

Is this an unhealthy hideout, where the market senses economic deterioration and money moves from growth to safer larger cap and dividend paying stocks as a last bastion of return before they too give way, get sold and move lower?

My own sense is based on a much simpler dynamic relating to seasonality. These divergences are occurring during the second and third quarters which are usually the weakest half year for stocks and so, if history is a guide, markets will remain choppy and ultimately frustrate most until middle to late September.

As such, I continue to think you sell the rips and look for bargains for the longer term during the most notable periods of fear and loathing.

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