Tuesday, April 20, 2010

ETF Pairs as Sentiment Gauges: IWM and SPY

Recent posts have looked at EEM vs. SPY and XLY vs. XLP as sentiment gauges for the broad stock market. Above we see yet another ETF pair, IWM vs. SPY, as a gauge of speculative sentiment among traders and investors.

The underlying logic is much the same as EEM vs. SPY: traders will be drawn to the smaller, more entrepreneurial, growth-oriented companies when they anticipate economic expansion and will gravitate toward the larger, safer issues when they expect economic weakness.

As we can see above, the small and midcap stocks that are part of IWM have been outperforming the large cap SPY issues, recently moving to relative strength highs. That strength can also be seen in the advance/decline line specific to NYSE common stocks: the broad list of smaller cap issues has been moving the line to bull highs lately.

It is interesting to juxtapose the bullish speculative sentiment of IWM vs. SPY with the more tempered outlook given by EEM vs. SPY. Within the universe of U.S. stocks, we see risk-taking sentiment among traders; that same sentiment is not extending itself globally. Indeed, if we look at large cap stocks across Europe, the Far East, and Australasia (EFA), we can see that those overseas bourses as a whole have not sustained bull highs thus far in 2010.

As long as there is broad participation in upward movement in the U.S., I don't expect any major market correction. Should we begin to see small caps underperform their larger cap counterparts and overseas markets--especially in emerging economies--underperforming the U.S., I would become far more defensive.