Chart of the Day – IWM / SPY Ratio Hits 1 Year Low

by Enis May 8, 2014 2:13 pm • Commentary

Another day of IWM acting terribly, clinging to its 2014 support for dear life…another day of SPY getting awfully close to breaking out to a new all-time high.  That’s been the story for much of the past month, and today is no exception.

Dan summed up our thoughts on this ongoing divergence in today’s MorningWord:

I know I sound like a broken record but I have to tell you that the bifurcated price action in U.S. equities leads me to only one conclusion – we are going much lower at some point this year. I can’t tell you that we are going to crash, or that we will enter a bear market but as long as I have been in the business I have never seen a period where so many stocks have erased this amount of prior gains in such a short period of time without broader market implications.

For a chart view of the bifurcated price action, check out the chart of the IWM/SPY ratio over the past 5 years of the bull market:

IWM / SPY ratio chart, Courtesy of Bloomberg
IWM / SPY ratio chart, Courtesy of Bloomberg

The ratio has fallen to a one year low in the past week, and is actually not too far from the 4 year low of the ratio, just below 0.56, which was hit in October 2011.  Notice that the only prior pullback of similar magnitude over the past 5 years occurred during the severe selloff in the summer and fall of 2011.

Obviously, the current market action is not like 2011.  By the time the IWM/SPY ratio had fallen nearly 10% in that instance, the S&P 500 was already down nearly 15% from its peak.  Today, the S&P 500 index is down 1% from its peak.

One last note – given that the ratio is approaching 4 year lows, our view is that if there is further weakness in small cap stocks from here, it will finally drag the large caps lower as well.  This ratio has become quite stretched on the downside, and we expect some stabilization in the weeks ahead.  In other words, it might finally be time to trim some of those safe haven large caps that have held up so well.