Small caps point the way to green pastures

Kevin Pendley | Jul 22, 2008 4:34pm EDT | Comment

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Small-cap stocks posted a solid rally Tuesday, bolstered by sinking crude oil prices, a strong dollar and enthusiasm over a steady spate of merger and acquisition activity. The Russell 2000 (NYSE:IWM) rose 19.19, or 2.75%, to 716.82, marking the 9th-largest one-day gain of the year.

The recovery bounce in stocks from a morning slide was clearly paced by small caps as the Russell 2000 moved into the green well ahead of its large-cap brethren — and even well before the crude oil collapse gained momentum.

“Crude was helpful to sectors in the market, but today’s action was also dominated by a wave of earnings. The lack of material downside follow through in the financial sector post Wachovia, Keycorp and American Express sparked a bid. The market was able to shrug off the initial bearish news with surprisingly little downside, which is a big positive. In addition, M&A activity is perking up,” said Nick Kalivas, vice president, financial research with MF Global.

Kalivas said that the deal by Brocade Communications Systems (Nasdaq:BRCD) to purchase Foundry Networks Inc. (Nasdaq:FDRY) helped secure a positive tone for the market, particularly in small caps. FDRY gapped higher on huge volume today, and added some 30% to its market cap on the news.

Several airline stocks are in the small- to mid-cap range, and those stocks really took flight today as crude oil tanked. The AMEX Airline Index shot 22% higher today, and small-cap carrier US Airways (NYSE:LCC) jumped a whopping 59% despite reporting huge — but not surprising — quarterly losses. Small-cap firm Alaska Air Group Inc. (NYSE:ALK) was up 19%, while JetBlue Airways Corp. (Nasdaq:JBLU) rallied 20% and UAL Corp. (Nasdaq:UAUA) gained some 63%.

As for crude oil, the market for black gold went into a tailspin, sinking some 3% to 6-week lows. Clearly, the rise in the U.S. dollar went hand-in-hand with the plunge in crude, but one could argue that the dollar rally also played in a role in pulling down commodity prices across many markets. For instance, corn was down 3%, sugar down 3%, orange juice down 2.7% and even gold reversed overnight gains to slide 1.6%. The Commodity Research Bureau Index of 19 commodity markets was down 1.7% to 7-week lows.

The eventual rally in equities today was an impressive finish to a session that looked bleak in the beginning. Nasdaq futures were flirting with 2% losses overnight amid poor earnings results from key players like Apple Inc. (Nasdaq:AAPL), Texas Instruments (NYSE:TXN) and Vodafone Group PLC (NYSE:VOD). What’s more, for the first time in several days the financial group was on wobbly footing as Wachovia Corp. (NYSE:WB) and American Express (NYSE:AXP) appeared to disappoint with their quarterly results. However, WB shares eventually shot 25% higher as the firm said it would not sell stock to raise capital. Once again, bank stocks found favor with investors in a familiar refrain that has run through Wells Fargo & Co. (NYSE:WFC), JP Morgan (NYSE:JPM), Citigroup (NYSE:C) and now Wachovia.

From a trader’s perspective, Kalivas said that equities will primarily focus on earnings and crude oil price gyrations the rest of the week. “The ability of financials to hold gains will also be important. I don’t think the macro numbers mean a whole lot, although housing data will get a look late in the week,” he said.

Looking at the chart picture, the Russell 2000 broke out to the upside of the recent range and pulled above the 50-day moving average for the first time in four weeks since the market entered collapse mode toward the lows. Persistent action through some of these key moving averages could easily trigger some “black box” buying from systems traders and may have played a role in the advance seen on index products Tuesday. As for Wednesday’s action, resistance is just overhead at 717.50. If the market can punch through that zone, then resistance is at 724, but it lacks the clear importance of the area near the former. On the downside, any slide back below 701 would jeopardize the breakout staying power of today’s advance.

Broad market sectors on the rise today were highlighted by diversified banks, specialized finance, regional banks, diverse financial services firms, airlines, tires and rubber, hotels and managed health care stocks. The big losers were dominated by a commodity theme, including coal, metals, oil exploration, steel, gas utilities, oil storage and mixed in with some tech names like semiconductors.

Small-caps on the move included ATA Inc. (Nasdaq:ATAI), which soared 22%, ShoreTel Inc. (Nasdaq:SHOR), up 23% and back from the brink of move lows last week. Also, Bluegreen Corp. (NYSE:BXG) exploded 87% on unusually heavy volume on news that the company will be sold for $500 million, or $15 a share to Diamond Resorts. On the downside, KVH Industries Inc. (NYSE:KVHI) was off some 16%, dramatically reversing a big rally from Monday.