News flash! On Wednesday morning, the Nasdaq Composite gave the financial media has another round number to discuss when the index briefly crossed the 3,000 barrier at 10 a.m. EST — the first time it has traded above that level since December 2000.
The Nasdaq’s move to a millennial high is the latest in a series of milestones for the U.S. market, following closely behind the S&P 500’s cross above 1,370 and the Dow Jones Industrial Average’s successful assault on the 13,000 level.
It makes for a compelling headline, but the real clue to the market’s near-term direction might in fact lie in the recent performance of small- and mid-cap stocks.
There are two reasons why the Nasdaq isn’t the best indicator for the health of the overall market right now. First, the index doesn’t have the cachet it once did. While the index was used as the key technology barometer a decade ago, today the Nasdaq 100 Index (NDX) receives more attention as a broader play on large-cap tech. The gap can be seen in the assets under management in the related ETFs: while the PowerShares QQQ ETF (NASDAQ:QQQ) had net assets of just over $31 billion on Jan. 31, the Fidelity NASDAQ Composite Index ETF (NASDAQ:ONEQ) checked in with just $166.3 million. In that sense, some big, round numbers are more important than others.
The second factor to consider is that — like the NDX — the Nasdaq is largely driven by a handful of mega-cap giants. The top 10 holdings make up nearly 40% of the index, with Apple (NASDAQ:AAPL) weighted at over 10% and Microsoft (NASDAQ:MSFT) not far behind with a weighting north of 6%. Year-to-date through Tuesday, the two stocks had returned 32.2% and 23.6%, respectively, making them the key factors in the Composite’s return to the 3,000 level. At the same time, the other top eight stocks in the Nasdaq — which together barely surpass the combined market cap of Apple and Google — are in line with or behind the index year-to-date:
|Composite Index ETF||ONEQ||+14.4%|
The takeaway is that any move in the Nasdaq above the 3,000 barrier is less of an indicator of broader market performance right now than it is the returns of Apple and Microsoft. And in both cases, the magnitude of the stocks’ year-to-date rallies is less a sign of improving fundamentals than it is the massive amounts of cash being put to work in the largest, most liquid stocks in the market.
Investors therefore would be better served by monitoring these two tech giants for signs of a reversal instead of focusing on arbitrary index numbers. As was the case with gold in the early autumn, both are prime candidates for profit-taking if large investors decide it’s time to cut their risk exposure.
Investors also should pay attention to two the indices that could hold a better clue to the market’s direction than the Nasdaq Composite. Both the S&P 400 Mid Cap Index and the small-cap Russell 2000 Index have failed to follow the Dow, S&P 500 and Nasdaq to new high ground thus far. At midday Wednesday, the Mid Cap Index was about 3.6% off of its 52-week high, while the Russell was still 5.9% short of its 2010 high. Both look to be losing momentum in recent weeks, even as the large-cap indices continue to put in new highs.
Keep this in mind amid the “Nasdaq 3,000” headlines that should be coming our way in the days ahead.
As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.