Stocks began the week on a flat note as small- and midcap stocks, represented by the Russell 2000 and Nasdaq, fell 1.8% and 0.8%, respectively. The Dow Jones Industrial Average declined just 0.3% and the S&P 500 fell 0.4%.

Volume was light, but with second-quarter earnings due out today, both investors and traders alike appeared to hold back, waiting for the first results. Traditionally the first out of the gate is Alcoa (AA), which will report earnings after the close. Analysts expect AA to report Q2 earnings of 12 cents on revenues of $5.61 billion.

On Monday, the slide was led by chip-makers and biotechnology stocks. The iShares Nasdaq Biotechnology ETF (IBB) lost 2.6% closing at $259.09, off $6.93. The PHLX Semiconductor Index fell 0.7%, but the broader technology sector was unchanged.

There were no domestic economic reports to account for the losses. However, weaker-than-expected German industrial data took European stocks lower.

At the close, the Dow Jones Industrial Average fell 44 points to 17,024, the S&P 500 lost 8 points at 1,978, and Nasdaq closed at 4,452, down 34 points. The NYSE’s primary market traded less than 600 million shares with total volume of 2.6 billion shares, while the Nasdaq traded 1.7 billion shares.

On the Big Board, decliners outpaced advancers by 2.2-to-1, and on Nasdaq decliners outnumbered advancers by 3.9-to-1.

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Click to Enlarge

Both the Russell 2000 and Nasdaq took serious hits yesterday as wave after wave of negative commentary from the media resulted in lower prices. This, for the Russell 2000, resulted in the deepest decline in several months but didn’t result in any serious breach of support. Initial support for Nasdaq is close to yesterday’s low at 4450, and subsequent support rests at its near-term trend line at 4410 and then the major support line at 4373.

Conclusion

Most of the analysis was focused on the “overvalued nature of the small- and mid-cap stocks” and the unlikelihood that they could live up to Q2 analysts’ expectations. Even Jeff Saut of Raymond James, who is not prone to exaggeration, said that the “current set-up in the equity market is remarkably similar to the summer of 2011 that ushered in an 18% decline.” Jeff, however, said that any decline would probably not be that severe, but he thinks that the market could be “vulnerable to a 10%-12% decline.”

I prefer to stick with what is known, and that is that we are somewhat overvalued and, as noted on Monday, approaching “the three-month cycle of August through October (which) is usually the worst three months of the year.”

Traders and long-term investors, while remaining on the long side, should take smaller positions and exercise very tight stops. A split of 50% cash and 50% high-quality stocks is appropriate for investors. Traders may take either side of the market, but with great care since high volatility could result in wide swings.

Today’s Trading Landscape

To see a list of the companies reporting earnings today, click here.

For a list of this week’s economic reports due out, click here.