Two Steps Forward, One Step Back?

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April 29, 2009 1:29pm NASDAQ:QQQQ NYSE:IWM

questionConsider that since the current rally started on March 10, smaller stocks have been outperforming their bigger brethren. For example, the prices of the iShares Russell 2000 (NYSE: IWM) and the MidCap SPDRs (NYSE: MDY) have shot up roughly 30% in that period.

By comparison, the S&P 500 SPDRs (NYSE: SPY) is up some 20% since early March. Interestingly enough, prices on the Rydex S&P 500 Equal Weight ETF (NYSE: RSP) have jumped around 30% since early March. That illustrates how an equal-weighted index can capture smaller company outperformance. Normally in a rebounding economy, it’s more likely to see a quicker turnaround in fortunes at a small-cap name than a huge goliath…..

What if stock markets do start to collapse? Technical indicators show that the first floor for such a falloff would be around 825, or about 5% less than current levels. But major support levels really would come into play if the S&P 500 dropped closer to 800. That would demonstrate a much more significant test to the market. And such an 8% fall might be healthier in terms of setting up the broader market for a longer-term run.

……The argument that some sort of pullback at this point is overdue does make sense. Consider that starting in the second week of January through early March, the S&P 500 fell eight out of nine weeks. Then, it went up six straight weeks. In fact, the PowerShares QQQ (Nasdaq: QQQQ) is on its eighth straight week of price improvements……

……Another theory is circling around Wall Street these days that might be worthwhile to keep in mind. The contention is that trading desks at key financial institutions involved in government bailouts are heavily using leveraged ETFs and similar vehicles to make a profit.

Although such rumors are sure to bring more fuel to the fire about the role of leveraged ETFs in courting volatility, investors need to focus on what’s important. The point isn’t whether leveraged ETFs are proper investment vehicles or not—that’s up to each individual—it’s that credit markets are a long way away from unfreezing.

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