Weak commodities, cautious earnings, techs weigh down small caps

Kevin Pendley | Oct 21, 2008 4:23pm EDT | Comment

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Small-cap stocks closed lower, pulled down by slumping commodity markets, a cautious tone amid peak earnings season and lagging performance in the tech sector. The Russell 2000 (NYSE:IWM) closed down 16.18, or 2.96%, at 530.65 and is now down 31% for the year. For the first time in many months, the Dow has actually pulled virtually even with the Russell for 2008, while the S&P 500 is off 35%. Just a few weeks ago, the annual performance spread between the Russell and Dow was in double digits on a percentage basis, so the recent collapse in the spread between small- and large-caps reflects an even more aggressive flight out of “riskier” small-cap fare from investors.

If Monday’s big rally was primarily about energy, then today’s slide had a few more tentacles in play, but the main theme in motion was about the economy and whether or not global slowing would continue to get in the way of the stock market.

From a global standpoint, a recession in the United States and a sharp downturn around the world will hurt demand for commodity goods, a theme that played out today … not just in the U.S. market, but around the globe. Perhaps the perfect poster child for that theme today was the copper market, which crumbled to the lowest point since December 2005 and is now off 50% from the spring highs. A big part of that pullback is linked to China, where GDP slipped below double digits this week for the first time in five years. And the whole bearish commodities story surely got an extra kick from a big rally in the U.S. dollar, which makes commodities priced in dollar terms more expensive — and therefore crimps demand for those products. The greenback soared more than 200 basis points, or some 2% against the euro, making not just new highs for the move but also charging to the highest point since February 2007. With the dollar on a rampage and commodities limping on demand fears, crude oil’s rally from Monday was short-lived. Crude oil futures plunged some 4% and quickly took some of the shine off Monday’s energy-led rally.

This tug-of-war between valuation and the economy is always in play for the stock market, but is truly center stage right now as investors try to decide whether or not stocks are cheap enough down here to warrant the risk. Even though the market was lower today, there were still bargain-hunters in the mix; the Dow rose briefly to positive territory in the afternoon before going back into retreat mode and small-caps came teasingly close to a green print. However, when looking at money flow patterns, it was clear that many investors were simply liquidating commodity holdings and moving into a safer-haven, like Treasury products. Benchmark 10-year notes rallied hard today, which pushed the yield on notes down some 3.3%.

With no economic reports on tap today and no big speaking engagements out of Federal Reserve of Treasury officials, this session was supposed to be all about the wave of corporate earnings. While earnings were a big part of today’s action, it seemed like the market overlooked many of the results to focus in on worries in the tech sector after Texas Instruments Inc. (NYSE:TXN) missed the forecast and shed nearly 6%. The tech-laden Nasdaq 100 was off 5% today, following the lead from TXN and in the shadow of weakness from BlackBerry gadget maker Research in Motion Ltd. (Nasdaq:RIMM), which lost 5% today after sinking some 8% Monday.

What’s more, the primary worry on the tech front circles right back to the economy concerns and put a cautious tone on the corporate profit outlook — even from the firms that reported decent earnings. All that said, there were positive stories to be told today on the earnings front. For instance, 3M Company (NYSE:MMM) beat the consensus and rallied nearly 5%. Also, Pfizer Inc. (NYSE:PFE) beat the forecast and climbed some 1%.

Within the small-cap spectrum, ENGlobal Corp. (Nasdaq:ENG) was down 34% as the firm released preliminary earnings that were hurt by Hurricanes Ike and Gustav and high labor costs. Telecom Argentina SA (NYSE:TEO) tumbled 24% as overseas ADRs took a hit on the commodities scare and as Argentina’s Merval Index tumbled 13%, fueled by reports the government will take over nearly $30 billion worth of private pension funds.

The chart picture for small caps is basically right about where we started the week. While it’s disconcerting that the market can’t sustain rallies for more than a day at a time, it certainly beats the relentless collapse that was in play for the previous three weeks. The sideways consolidation we’ve seen the past three sessions either helps set a slightly higher foundation for another bounce leg up, or it suggests that the market was simply working off oversold momentum readings before resuming the downtrend. From a strict mathematic standpoint, the odds favor a bearish resolution of this consolidation, but it would take a slide back through figure support at 500 to truly suggest that the lows need tested and that another wave down is in order. On the upside, any decisive push through 550 would help set the table for a run at 615.