The corporate credit event isn’t here… yet. While my timing has been wrong on a crash despite conditions favoring it, I remain undeterred. Nothing has changed. We went through an incredible dislocation in Treasurys and the fastest rate hike cycle in history, and we are now experiencing overconfidence from the bulls. This all suggests a tail event is still more likely in equities than most want to admit.
Having said that, you can still occasionally speed up when driving in a storm if there’s an opportunity to get ahead of the car in front of you. As noted in The Lead-Lag Report, all my risk-on signals flipped at the end of last week. We are above the 200-day moving average, utility stocks weakened, and the ratio of lumber to gold is spiking. My work is quantitative, and the way these ratios have turned aggressively is NOT suggestive of something that lasts for a while. If anything, I think there’s a one-to-two-week risk-on dynamic here before we flip back to a defensive stance.
This is where those really looking for a quick trade can perhaps shine if I’m right about the short-term path potential. While the S&P 500 rallied last week, small-cap stocks didn’t. Quite the opposite – the Russell 2000 went down over 3%, and the ratio of small-caps to large-caps made new lows. That may be exactly why small-cap stocks could be due for a short-term reversal rally here.
Does that change anything I’ve said about the risk of a credit event? The risk of zombie companies not being able to roll over their debt into higher-for-longer rates? The risk of many of these companies not surviving? Of course not!
But there is a trade here on the speed with which small-cap stocks have weakened relative to large-cap stocks.
The Bottom Line on Small-Cap Stocks
Again, I don’t think this is some long-term dynamic. I also am not convinced this is seasonal rally either. I think more likely it’s just a “technical bounce” that could end up being a false read on a reacceleration of overall stock market momentum. But one thing I can argue is it’s definitely a potential tradeable bounce that nimble traders may want to play in the next 5-10 trading days.
On the date of publication, Michael Gayed did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
