Risk-On Sentiment Resumes

Market Moves

As on Monday, Tuesday also saw small-cap stocks as a group far outperform their large-cap counterparts, potentially further suggesting a risk-on market sentiment. The small-cap Russell 2000 index closed on Tuesday over 1% in the green for the second consecutive day, even as the large-cap indexes (S&P 500, Dow, and Nasdaq) remained flat to slightly lower, weighed down for much of the day by wavering tech stocks.


As we noted yesterday, small-cap stocks are considered by many to be both a gauge of investors’ risk appetite as well as a leading indicator of the broader stock market. Therefore, when we see the Russell 2000 surge, especially when large caps lag, it’s often seen as a sign that investors are willing to take more risk.


But one of our very astute readers instead attributes the strength in small caps versus the lackluster performance of large caps in the past few days to “a rotation out of primarily growth stocks and into the lagging smaller caps.” The reader goes on to say that this actually displays investor skepticism and lack of confidence as investors reject top names in favor of bottom fishing for small-cap laggards. This could very well be the case.


But one thing remains rather clear – there are signs of improving investor sentiment. This includes sharp pullbacks in traditional safe-haven assets, most notably gold. It also includes the sizable pullback in bond prices in the past several days. We’ll cover the charts of these below.


As for the chart of the small caps, the Russell 2000 index surged a whopping 1.23% on Tuesday, just slightly less impressive than its performance on Monday. In the process of this week’s surge thus far, the index has broken out above both its 200-day and 50-day moving averages, a significantly bullish technical event. The next major bullish target is around the 1,600 handle.



Gold Accelerates Pullback

Since May, the parabolic rise in the price of gold has attracted much media and market attention. Part of what drove this prolonged surge for the precious metal have been recent fears about trade conflicts and a slowing global economy. As gold is considered the most prominent “safe-haven” asset, investors tend to flock to the metal when things start to get dicey. Also, a lower interest rate environment helps contribute to accelerated buying of non-interest-bearing gold.


But as shown on the chart of the SPDR Gold Shares (GLD) ETF, which is physically backed by gold, the past week has seen gold pull back sharply from long-term highs. In the case of GLD, the ETF has dropped around 4.5% from its six-year high reached just last week. This is a significant pullback that, if it worsens, could break the integrity of the recent uptrend. Price has reached back down to a key uptrend support line. Any breakdown could accelerate the drop in gold prices, further reinforcing a risk-on market sentiment.











Bond Prices Tumble

Finally, Tuesday also saw an exceptionally sharp one-day pullback for bond prices as bond yields continued to rebound sharply. The iShares 20+ Year Treasury Bond ETF (TLT) dropped nearly 2% on Tuesday, which is no small feat for this particular ETF. This drop occurs just as bond yields appear to be bottoming out, with the 10-year Treasury yield having risen by over 20% in the past several trading days alone.


As shown on the TLT chart, the drop in bond prices from late August’s multi-year highs has been pronounced, at more than -5.5%. For now, there’s still strong support around the 200-day moving average, but any drop below could signal more substantial downside for bonds.



The Bottom Line

The apparent market rotation into small-cap stocks may or may not be connected to greater risk appetite on the part of investors. But one thing remains rather clear – market sentiment appears to have improved significantly, as evidenced by the recent drop in gold and bond prices. There are still major risk events on the horizon, including upcoming U.S.-China trade negotiations and next week’s Fed decision. But for the time being, the overall market bias has appeared to shift higher.


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