Global Trends ETF: Large Caps Vs Small Caps & Emerging Markets

The Global Trends ETF Report is a weekly update of broad market risks and trends, as well as, Plug & Play ETFs to focus on now.

Get started with “Using Plug & Play ETFs and Technical Trading Basics: Using Overbought And Oversold Signals To Buy And Sell.


Note: I will be appearing on ForexAnalytix FACE webinar tomorrow morning as a guest. I will be talking oil and the transition to clean energy. If you’re not watching this team’s morning show from time to time to get the pulse of the market, you are missing out. 


Market Risk Review

When I talk about stock market risk, I am talking about a few simple ideas. The first is the overbought vs oversold situation on the RSI and other measures.

With RSI, and other indicators, I am talking about longer term time frames, such as weekly and monthly ending charts. The default setting you see in most places is for daily charts. Those are for regular “swing traders,” folks who measure their trades in days, weeks and months.

We are mostly “position traders” who measure our trades in quarters and years. With that reality, it is important to ignore most of the day to day noise and focus on longer-term trends. 

Here are looks at a couple weekly charts of the S&P 500 (SPY) (VOO):

First, we have Shooters Elliott Wave Chart. The target for the S&P 500 is a bit higher, but certainly could break down ahead of time as markets like to be tricky. His downside is towards the middle 300s, with the 200-day moving average being an important support. Any break below about 315 would signal an “Armageddon” event of some sort. 

Next is my long-term TradingView of the S&P 500: 

We certainly could see a rally to $500 on the S&P 500, but I do think that is more likely next year after a pullback sooner. Take a look at the weekly RSI: 

When the RSI gets overbought on the weekly RSI like that, it 100% time has preceded at least a 5% correction. The only question is how much deeper could it get and can it go higher into overbought territory first. The answers are a lot more and maybe. 

ForexAnalytix makes the point that: “There are still many sources of uncertainty in the world, but equity markets seem to be shrugging them off without a second thought. The unprecedented global stimulus is reason enough to be bullish, but at these extremely rich valuations it’s difficult to be long. The prudent thing is to probably wait for a proper pullback before getting long, but will it come? We need to see a major technical break lower before we turn bearish – Neutral stance for now.” 

The mention of “extremely rich valuations” is a lead into the second factor I look at, which is, valuations. Let’s take a look at the 12 month trailing P/E from a historical perspective: 

As we can see, the P/E ratio is very high. However, that is coming off a 12 month period where earnings were lower and in a very low interest rate environment. So, let’s look forward 12 months when earnings comps will be harder to meet and beat: 

As you can see pretty clearly above, small caps have already corrected significantly. This has been going on for months now as people chased large caps ever higher. That chasing of large caps is into the face of what are likely to be slowing earnings early next year.

The small caps provide a much wider margin of safety as there is growth to be found there and very little optimism pushing prices up lately. And remember, given the smaller market caps, there is a much larger potential for small stock prices to surge higher on any interest from investors who buy up the limited floats. This is why my “Stocks Of The Week” article has been loaded with small caps lately. That’s where the margin of safety and upside are right now.

The Sentiment Trader chart below, allows us to see what the “smart” and “dumb” money are doing now: 

It’s rare the smarter money (institutions, hedge funds, family offices) and the dumber smaller (retail) money move in the same direction. Although, in the past year, they have for periods of time, which is interesting. Right now though, the smart and dumb money are moving in opposite directions. This usually ends up badly for retail investors with less experience. 

In talking to several Reddit “Apes” lately, it is clear to me that there is a gambling mentality and low appreciation of fundamentals or history. The mantra right now is “the Fed has our back” and “fiat money sucks to buy crypto.” To me, that’s a pretty weird construct. 

There are a bevy of interesting charts at Sentiment Trader. One I like is the intermediate term optimism which observes “the extremes currently registered by a series of intermediate-term indicators that have had the greatest success in highlighting extremes in price.”  

You can see that while optimism is high, it is not “crazy high.” But, the trending optimism has been falling all year. So, the question to ask I think is:

do we see a surge in optimism and prices on a breakout, or, are we about to see a significant fall in optimism and price as the trend continues? 

I fall back to the valuations. With large cap earnings comps becoming more difficult on earnings and the economic growth from the rebound waning, I am more cautious again on large caps, though there are a few companies I think are unfairly ignored or misunderstood now. I am selectively picking out small cap names individually. 

If large caps are going to continue higher, then it is probably the Nasdaq 100 stocks (QQQ) that pushes the broader S&P 500 up. The largest companies in QQQ are also among the healthiest companies in the larger S&P 500 universe. Collectively, the QQQ holdings carry about 70% of all the corporate cash in America. What does that say about the other 400 companies on the S&P 500? 

My technical analyst and I have similar views of QQQ’s quality and potential. He sees one more potential puff on the cigar before a brief, but potentially deep correction: 

I see a correction, but also, continued long-term outperformance of QQQ vs SPY/VOO. 

Short answer then? Be cautious with new money to invest, trim where appropriate to raise cash and look for opportunities in small caps now and QQQ later. 

Emerging Markets Best Bet

As followers know, I am a fan of Jeremy Grantham at GMO. I believe, as he does, that the biggest trends out there are clean energy adoption and emerging markets growth. Today, let’s look at Emerging Markets. 

As you can see, the emerging markets ETF I use is the Emerging Markets Internet & Ecommerce ETF (EMQQ). It is composed of asset light companies in cloud, ecommerce and technology platforms. I compare it to the more heavily quoted iShares MSCI Emerging Markets ETF (EEM). 

To me, the reason that EMQQ outperforms EEM is similar to why QQQ outperforms SPY. The companies in EMQQ are more tied to the modern technology and consumer driven economy.

As more people in the emerging markets enter the middle class, which is happening fast, they will skip many phases of economic development that we in the west went through over the past several decades. That is, they will go straight to ecommerce and bypass the “department stores and malls every 10 miles” phase. 

Ecommerce, as logistics develops, has the potential to be a massive grower for a generation in Central and South America, Mexico, Eastern Europe, SE Asia, India, the Middle East and Africa. 

The way EMQQ’s chart looks, there is another price dip coming. Whether it retests the recent bottom and rebounds, or falls through the recent bottom, is the main question. 

From a valuation standpoint, I can see an eventual price on EMQQ of around $40, which also marks an important long-term support level. However, valuations haven’t mattered a ton lately, so maybe a price around $48 is more likely. 

I am going to take a starter position around $48 if there isn’t big downward momentum at that time.

I will also sell a cash-secured put with a strike of like $45 per share a couple months out which should net me a premium that gets that batch to me around $40 if the market continues to correct.