On a day like today, after a big drop, I think the markets are more about emotion than they are about facts and fundamentals. Therefore, I find it useful to look at the charts for some guidance about how people are feeling.
Yesterday, both the Dow and the S&P closed below their 50 day moving averages – the S&P actually closed below it’s 50 day moving average on Tuesday, on the Countrywide inspired drop. Generally, stocks trading above their 50 day moving average are showing strong upward price movement.
These are very important levels for both indexes. They represent long term support and any close below them is sure to cause a lot of fear. These are the two numbers I’m paying the most attention to right now.
However, it is significant that the Russell 2000 index of small companies closed below it’s 200 day moving average yesterday (chart).
In fact, the Russell 2000 has significantly underperformed the broader market since earnings season kicked off two Mondays ago – down 9.5% compared to the S&P 500’s 5.5% (chart).
Why? What does it mean?
The Russell 2000 is an index of small companies. Smaller companies generally sell most of their stuff to the domestic i.e. US market.
One of the themes since first quarter earnings has been the continuing strength of international economies in contrast with the slowdown in the US economy. The biggest reason S&P 500 companies produced such good, and surprising, earnings in the first quarter is the fact that so much of their revenues now come from overseas which insulated them from the US slowdown and allowed them to keep churning out good earnings.
The Russell 2000 is therefore far more exposed and dependent on the domestic, US, economy – which is slowing in the face of a crashing housing market and a slowdown in credit. And that’s why it is underperforming. The charts tell the story: investors believe that international markets will at least hold up while the US economy will continue to be slow.
I believe smaller companies and the Russell 2000 are just beginning a substantial downward move which could be the beginning of a bear market for them.
There is one other interesting thing the charts are telling us: Big Tech is strong.
The Nasdaq-100 Trust, an index of the 100 largest stocks traded on the Nasdaq, is still trading above it’s 50 day moving average (chart). And big tech has been blowing away the rest of the market for the last month or two (chart). Traditionally a highly volatile sector, tech is one of the strongest parts of the market right now – along with healthcare and consumer staples.
(I commented on the stength of big tech 3 weeks ago – also highlighting that a few big names were doing alot of the heavy lifting).
Again: Why? What is the meaning of this?
My interpretation is that we are in the midst of technological revolution involving globalization, the internet, online advertising and mobile devices that is insulating big tech from this selloff because investors believe that this trend will continue to support big tech earnings even in the face of the current credit concerns and the slowdown in the US economy.
That’s my interpretation of the chart and, again, as in the case of the Russell 2000, I think the market is probably right about this.
UPDATE (Fri 7/27, 11:30am PST): MarketBeat has a post on how the Russell 2000 is getting hammered.