As we have noted in prior reports and posts, there have been a number of abnormalities taking place in recent weeks regarding the rally in the S&P 500. Whether it is the recent underperformance of the Russell 2000 or the divergence in the DJ Transports, trends we typically expect to see as the market rallies haven't really transpired.
Another notable aspect of the rally over the last week or so is that it has been accompanied by strength in the dollar. Over the last ten years, we have grown accustomed to rallies in equities being accompanied by a weak dollar, but over the last two weeks, both the dollar and S&P 500 are up. Even over the last year, the inverse correlation between the two assets has not been as pronounced. In fact, at the end of 2011, we saw a similar trend when the dollar and the S&P 500 both rallied in step with each other until the dollar took a breather in January.
While the divergence between the S&P 500 and small caps and transports is generally considered a negative, outside of the last ten years, rallies in equities usually occurred hand in hand with a run higher in the dollar. So while continued divergence between the S&P 500 and small caps and transports would be a negative if it continues, we would view the strength in the dollar as a positive for equities.
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