A Rareview View: Small vs. Large Caps: $SPY/$IWM

Below is excerpt courtesy of 07.29 edition of Rareview Macro’s “Sight Beyond Sight”

Small vs. Large Caps

Below are two charts of the ratio of the S&P 500 (symbol: SPY) to the Russell 2000 (symbol: IWM).

The first chart shows the performance of the ratio (i.e. long SPY vs. short IWM) on the top each time the relative strength index (i.e. 14-day RSI) reaches ~70. This ratio is currently overbought.

Neil Azous, Rareview Macro LLC
Neil Azous, Rareview Macro LLC

Going back to 2009 there have been ~10 points in time where the RSI reached ~70 (i.e. overbought) using the standard 14-day period. The average gain in the ratio is ~7.7% vs. the current gain at 6.6% off the July 2014 low.

The second chart shows the Fibonacci retracement levels following the GFC. The 61.8% FIB level is 1.2%. That happens to coincide with the average gain (i.e. ~7.7%) of the last 10 times that coincided with a ~70 RSI.

Courtesy of Rareview Macro's Sight Beyond Sight 07.29
Courtesy of Rareview Macro’s Sight Beyond Sight 07.29

We have placed an order to buy $20 million of IWM and sell short $20mm of SPY at this 61.8% retracement level. Out stop is the 76.4% retracement level which is ~2.7% above the 61.8% retracement level. That would equate to a loss of ~$540k or ~50 basis points of the NAV. As a reminder, we refer to 50 basis points as one unit of risk.

Right now this is a “tactical” trade we don’t need but if we get a great entry point we will add one unit. The key point here is that we are happy to be patient and wait for the right pitch to swing at.

Ideally we would like to see the SPY sell off 1% and IWM not underperform for a change. That would be a signal that the professionals are too one-way in their long SPY vs. short IWM view, and we would look to take advantage of that.

Finally, we would note that a number of paid forecasters are highlighting the correlation between small cap securities and high yield bonds. We are not sure if that is really the correct way to look at the backdrop in risk currently or which asset is actually leading. What we would say is that if the SPY/IWM ratio were to reverse than those looking for the S&P 500 to correct on further high yield weakness would have to wait even longer, especially now that the consensus is that earnings are supportive for risk.

“Sight Beyond Sight” is a subscriber-based, macro strategy newsletter published each day by Rareview Macro LLC’s Neil Azous and distributed to leading investment managers, hedge funds, select Registered Investment Advisors and sophisticated self-directed investors. The firm offers a 15-day free trial (no credit card required) via www.rareviewmacro.com Trade strategy ideas are incorporated into Rareview Macro LLC’s model portfolio, which is updated daily and position changes are publicized in real time via the firm’s Tweeter feed : https://www.twitter.com/rareviewmacro