Stay long the "risk" trade

Despite the Dow making marginal new highs for the week, there has been some angst among investors about the weakness of the small cap Russell 2000:

"Negative divergence," Cried the technicians! The standard explanation for this concern is that the "generals", large caps, are leading the market, while the small cap troops aren't following.

I think it's time to take a deep breath and look at the intermediate term trend in context. Consider the chart of the small cap Russell 2000 to the market, which is shown below. No matter how you slice it, the trend of small cap outperformance remains intact and panic isn't warranted.

Risk trade still looks bullish
The relative chart of the Consumer Discretionary stocks compared to the Consumer Staple stocks, shown below, is a good measure of risk aversion. While the short term uptrend in the "buy risk" has been broken, signaling that either a sideways consolidation or short-term correction, the intermediate trend remains intact.

Another way of thinking about about the risk aversion trade is to analyze the performance of the Morgan Stanley Cyclical Index (CYC) relative to the market. By this metric, the pro-cyclical trade remains in an uptrend.

I see that the latest sentiment figures shows the crowd is pulling back a touch from their extreme levels of bullishness. If investors are this skittish and they are ready to turn tail at the first sign of minor market weakness, then this sense of nervousness would indeed be good news for the bulls. Given the strong tailwinds from the presidential cycle and the strength of the underlying uptrends, I would be inclined to give the bulls the benefit of the doubt for now, at least on an intermediate term basis.