Shadow Capitalism On The Bearish Divergence, And Why It Portends Another Leg Down For The Dollar

Naufal Sanaullah at Shadow Capitalism weighs in on one of the biggest topics for traders, namely the underperformance of high-beta/small caps (which has been referred to as the invisible correction).

Sanaullah looks at the prospects of a larger market decline, and a new rally in US Treasuries.

An important point I’ve been mentioning lately is that the beta is underperforming, with the Russell trailing the S&P and everything trailing the Dow. Beta underperformance tends to mark turns often due to reversals in cyclically-sensitive securities tending to be leading indicators (indeed the breakout in IWM/SPY in late September led to me catching the subsequent rally early and from a great risk/reward standpoint), especially when leading on the way up, as the Russell did in late summer 2010. Below is the Russell 2000 priced in S&P 500, via IWM & SPY ETFs.


Another implication (particularly in the Dow’s outperformance vs the S&P) is the ratios’ correlations to Treasury yields, which suggests yields may selloff soon, while risk looks heavy with overhead resistance, which implies a return to the in-tandem movement of UST’s and USD, aka safe haven risk aversion. This is what characterised the top back in April 2010, and indeed the JPY surged ahead of and leading the May 6 Flash Crash in risk assets across the board. As such, I am positioned short equity, long USD & JPY, and back to long the belly of the UST curve. All of these are bets that can turn on a dime, and are risk/reward plays just as much if not more than they are thesis-driven trades. Below is the S&P 500/Dow Jones Industrial Average ratio (via the SPY & DIA ETFs), with 10yr Tsy yields overlayed.


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