Cyclical risk rotation underway

When the long-always crowd starts switching around their seats (on the equity titanic), it is historically a sign that the great risk-rotation has finally arrived in earnest. The below portrait of the small cap Russell 2000 Index divided by the S&P 500 Index since 2002, nicely maps out the cyclical recovery for risk assets from 2003 to 2007, the cyclical bear of 2007 to 2009, the cyclical recovery of 2009 to 2013 and the break down once more, year to date (similar to 2007).
Sentiment rotation July 30 2014
Also shown is where this risk ratio was rolling over in the late fall of 2012 before “whatever it takes” promises of Q’Ever from Central Banks prodded yet one more speculative leg in stocks to 2014. Since January, QE hope appears to be losing the battle in the stand-off with ugly valuation reality.

Lest one is distracted by the media parade banners this morning of a “robust” official first guesstimate of US Q2 GDP at 4%, it is important to appreciate that following -2.9% today revised to -2.1% annualized growth in Q1 (following a handy redefinition of how GDP is now calculated), this “big beat” for Q2 amounts to annualized growth in the first half of 2014 at a 1.1% 1.9% rate (on a rather alarming build in inventory produced but not sold–and likely to detract from Q3 orders as a result). And as always, there will be several more revisions coming to the first guesstimate before the number is firmed, and historically these revisions are lower not higher. So growth less than 2% in the first half with stocks in a select group of all time high valuations alongside 1929, 2000 and 2007. Good to know.

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