Stocks plunged on Wednesday as investors decided to dump shares of companies most closely related to cyclical economic growth. The funny thing is, they ramped up the very same shares a week ago because they were so excited about the prospects for improved growth. It’s like deja vu all over again, but backwards and with a full twist.
Small stocks were hit the hardest, as the Russell 2000 plummeted below its 50-day and 200-day averages. It was the largest one-day loss for the index since the 5% loss on June 4 when a Hungarian official compared his nation’s debt woes to those of Greece. The index is back to early July, wiping out a month of gains. I’m not one to say “I told you so” but let me just note that we have purposefully avoided exposure to the smalls in an effort to de-risk our portfolios.
While the weakness of riskier stocks is a cause for concern, for now technically this still looks to be a pullback within a new uptrend. That would make the Wednesday wipe-out a “terminal” move, meaning that it is unlikely to be extended with a lot of follow-through.
Blow-off events of this type act to clear away excessive bullishness and allows the uptrend to continue with a lighter step, after some consolidation. Down volume accounted for an overwhelming 97% of total volume while declining issues accounted for 86% of advancers plus decliners. This disparity pushed the ARMs Index to levels typically associated with short-term bottoms. Also, the percentage of stocks above their 10-day moving average has fallen under 9% And all 30 stocks in the Dow Jones Industrials Average fell, which is rare and tends to happen at lows, not when a decline is just getting started.
The last time the Arms Index closed at these levels was back on June 4. Stocks posted another day of losses before reversing and slinging into the mid-June high. I expect a similar scenario to play out now, with another day or two of much milder losses before the uptrend resumes.
Looking ahead, it appears that technology stocks — specifically semiconductors — should lead the way higher. Stocks in this sector were hit hard in the wake of cautious outlooks by Cisco (NASDAQ: CSCO) as they on one hand contend with a tight supply chain (pressuring margins) while on the other, they deal with customers that are still very nervous about the economic outlook. For a play on the industry, the Semiconductor HOLDRs (NYSE: SMH) looks attractive at current levels. Intel
(NASDAQ: INTC) looks very strong as well, and has formed a “bullish engulfing” pattern on an intra-day basis as shown in the chart above.
Be sure to check out Mirhaydari’s new advisory service, the Edge, which will be launched in September. He can be contacted at anthony.mirhaydari@live.com.
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