Developed markets have been slightly outperforming the S&P 500 over the past two months, but it’s been a slow and shallow climb. Sentiment remains miserable for consumer staples, which has seen zero momentum and keeps plunging to new lows. Small-caps continue to demonstrate uncommon strength.

Financials are finally getting a notable boost from the yield curve. Last week’s 5% gains for small-caps marked a return to the huge weekly gains the sector has become accustomed to over the past couple of months. With the exception of junk bonds, which are following the rally in risk assets, fixed income continues to lag. There has been some demand for dollar liquidity from defensive-minded investors.

A higher rate, higher inflation environment would certainly be the conditions that would support a bank rally in the new year. We did see small-caps noticeably underperform last week, but I’m not sure this marks the top of this rally. It seems pretty clear that the risk investors are protecting themselves from here is rising inflation.