As small caps have surged to record highs in the last week, a key theme for 2017 has emerged, according to Lindsey Group's Peter Boockvar.
In a note published this week, Boockvar wrote that the new year will bring "the push and pull over hopes for a liberated economy and the reality of higher interest rates on an economy and asset market place that have been built on artificially low interest rates."
Boockvar points to a chart examining the recent divergence between the iShares Russell 2000 ETF (IWM) and the High Yield Corporate Bond ETF (HYG) — a move he warns investors to watch as interest rates tick higher.
"If you look at small companies, the high-yield market right now and the sell-off that it's experienced over the past week, obviously coincident with selling in investment grade and U.S. Treasurys is the rise in the cost of capital," Boockvar said Monday on CNBC's "Trading Nation."
The Russell 2000 has rallied 12 percent in the last week while the HYG has fallen more than 1 percent and bonds globally have plummeted. High-yield bonds often serve as a proxy to where the stock market is going.
"And while I understand the enthusiasm for small cap stocks, because they're less sensitive to dollar strength, the index is populated with a lot of biotech and financials that have participated a lot over the past week," Boockvar said.
When paired with the higher cost of capital and higher interest rates "on an index that is very overvalued, priced at about 24 times next year's earnings," this is a divergence that cannot last very long, he added.
"And either yields are going to calm down, and bonds will bounce back, or this 11 percent rally in six trading days in the Russell is going to reverse itself," he said.
While Boockvar doesn't expect a "violent" move lower, he is bracing for more turbulence as investors digest how Trump's policies could play out, and how interest rates move.
On Tuesday, Boston Fed President Eric Rosengren stated the "high likelihood" of the Fed raising rates in December.