The small caps in the Russell 2000 — which Janet Yellen in her testimony to the House of Representatives on Wednesday admitted were possibly trading at overvalued levels — suggests trouble. On Tuesday, the index closed below its 200-day moving average for the first time since 2012, ending an 18-month-long uptrend. This was a breakdown long in the making: There were no less than seven attempts over the last two weeks.
The bulls simply couldn't resist the selling pressure any longer.The dichotomy is stark, and if history is any guide, it's downright scary. In fact, the gap that has opened up between small and large stocks was last seen near the very top of the last two bear markets.
Tuesday was only the third time in 35 years of market history that the NYSE Composite was sitting at a 52-week high one day before the Russell 2000 dropped below both its 50- and 200-day moving averages the next day. The last two occurrences were 3/12/99 and 11/1/07.
Moreover, small stocks aren't the only area warning of trouble. Despite declarations that the economy is re-surging after a harsh winter, U.S. Treasury bonds have been well bid — traditionally, a sign that the bond market is pricing in trouble. As a result, 10-year yields have dropped back to the 2.6% level, down from a high of 3.05% at the end of 2013.The inevitable question becomes this: Is the overall market bubbly enough to justify a major turning point? The answer: YES IT IS.
According to Citigroup research, the market stopped following the fundamentals in late 2012. That's when bond-market spreads disconnected from the amount of borrowing companies were doing, and it's when stocks stopped responding to earnings revisions.
If bond investors no longer care about the creditworthiness of the companies they are giving their money to, and stock investors no longer care about the earning of the companies they are investing in, then how is that anything other than a bubble.