SMALL CAPS SHOW MAIN STREET WOES DAVID MORRISON
WHILE many stock indices in the US and Europe hit fresh yearly highs last week, a flick through the charts points to a loss of upward momentum. The trend for most major indices remains positive, but despite a strong rally following the dip at the end of October, the markets are looking tired.
Focusing on the US indices, and looking at charts of the Dow Jones Industrials and the S&P 500, there is no obvious cause for concern. Sure, the rally is slowing down but given its duration and degree, there is nothing surprising about that. These indices have been on a sharp upward trajectory since they hit their crisis lows at the beginning of March, and both have now recouped 50 per cent of the losses made from their all-time highs back in October 2007. In the nine months since March, there really hasn’t been a significant correction, although we did see some consolidation over the summer.
But there are two other major US stock indices that also need watching. The first is the Nasdaq 100, which contains no financial companies and is heavily weighted towards technology stocks. It has a bias towards cyclicals and led the other indices into the rally. Consequently, if investors get the jitters they are likely to unload cyclical stocks and rotate into defensives – in this situation we would expect the Dow to outperform the Nasdaq. The second is the Russell 2,000 which is an index of 2,000 “small cap” stocks, where the average market capitalisation of the constituents is around $500m. Consequently, it is far more representative of the wider US economy and has a much smaller bias to mulinationals than the blue chip indices.
The chart for the Russell is worrying. As with the blue chip indices, it has retraced 50 per cent of its downward move from October 2007 to March 2009. But it made a high for the year back in September and now appears to be struggling.
We hear a lot about the disconnect between Wall Street and Main Street. Taxpayer funds have poured into the major financial institutions and the banks still standing are making record profits. Yet unemployment continues to rise and 123 regional banks have been closed down so far this year. Main Street is in trouble, although you wouldn’t know it from the Dow. But the Russell tells a different story.