Over the past few years we've cited the lagged relationship that exists between trends in the US dollar and the relative performance between large and small cap stocks. And although you'll often hear recited the confident truism that a weak dollar is better for large cap companies, the reality in the markets is a bit grayer, more nuanced and certainly more counterintuitive than most would suspect. While over shorter time periods a weak dollar has at times correlated with large cap outperformance, from a long-term relative performance perspective - small cap stocks have tended to outperform during major dollar downtrends and underperform during prolonged periods of strength. They outperformed in the 1970's with a weak dollar - and since 1999, the RUT:SPX ratio has continued to trend higher. Why? Like many causative motivations in the markets, it's likely a variety of interconnected and shifting conditions that is far more complicated than an old market adage provides. These range from leading industry cycles, to the attraction of capital by foreign investors - to whether hedging strategies were or were not implemented.
Fundamental reasoning aside, we have viewed the trend change in the SPX:RUT ratio this year as a potential major cycle pivot and have developed our longer-term market postures from the comparative bearings of the ratio's previous cycle low in 1994. If past is prologue, there exists an approximate one year lag between pivots in the respective cycles. When the SPX:RUT ratio failed to breakout last year and began to roll-over one more time, it was a leading indicator for us of a possible trend change downstream in the dollar, which we expected would eventually follow the ratio lower - similar to the market dynamics present in 1994 and 1995.
Despite the US dollar's strong performance throughout July, we remain confident that the index will follow the lead of the SPX:RUT ratio last year and plumb the bottom of its long-term range. Once again, emboldening the flawed truism for a spell that a weak dollar is better for large cap stocks.