Brief afternoon bounce rebuffed on profit worries, commodities slump

Kevin Pendley | Nov 11, 2008 4:25pm EST | Comment

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Small-cap stocks took a dive again Tuesday, rejecting a brief afternoon bounce into positive territory as concerns about the economy, tumbling corporate profits and slumping commodity markets continue to take a toll. The Russell 2000 (NYSE:IWM) closed down 10.81, or 2.19% at 482.29, the third-lowest daily close in more than five years (all of which have taken place since late October). For the year, small caps are off 37%, while the Dow is down 34% and the S&P 500 is down 39%.

Energy, insurance, retail, technology and financial stocks were major sources of weakness today. Homebuilders, drug stocks, agriculture products and home entertainment software companies lagged the overall market downdraft and some real estate investment trusts (REITS) had a bounce after getting clobbered Tuesday.

The Russell actually pulled into the green around 2:30 p.m. ET, when BlackRock president Robert Kapito said that a $30 billion Bear Stearns mortgage portfolio could be worth more than market expectations. The bounce got additional fuel when housing agencies Fannie Mae and Freddie Mac said that homeowners facing foreclosure who were paying more than 38% of their income on mortgage payments could have those payments reduced. On Monday, Citigroup Inc. (NYSE:C) launched a program that could result in $20 billion worth of refinancing in an effort to keep people in their homes. JP Morgan Chase and Co. (NYSE:JPM), who recently took over Washington Mutual’s massive mortgage portfolio also announced measures in recent days to help out stem the heavy flow of foreclosures. Just a couple of weeks ago, RealtyTrac estimated foreclosure filings at a record number of more than three quarter of a million homes, up a startling 71% in the third quarter.

U.S. equities got a sour start to the day when markets in Asia and Europe were reeling from sinking financial, energy and commodity shares. The European market shed about 4% on the day, while markets in Japan lost 3%, Australia was off 3.5% and India was down 6.6%. But the worst news came from Russia, where the Micex Stock Exchange halted trading for two days when the market tumbled 12%. Russia is the second-largest oil producer in the world and in addition to the commodity woes right now, had to raise interest rates today to fight off capital outflow and inflation at a time when the rest of the world has been slashing rates to battle sluggish economic conditions.

Crude oil prices tumbled to 20-month lows, slipping below $59 a barrel as concerns about demand continue to chip away at commodity valuation. Data from China overnight showed that import growth was slowing (China is the second-largest importer of energy behind the U.S.) and that inflation was at a 17-month low. The slide in physical markets gained momentum as the dollar rallied against the euro, with the greenback climbing more than 1.5% as the day progressed. A stronger dollar tends to hurt commodity prices, most of which are traded in dollar terms. The Commodity Research Bureau Index of 19 commodity markets tumbled some 3%, sinking to the lowest point since December 2003. Remember back in July when people were talking about crude reaching $150 a barrel and commodity price inflation was a hot topic? Since the July peak, the CRB has collapsed 46%. Hedge fund managers were reportedly heavily invested in commodities and commodity-themed stocks and as they all scrambled for the exit, selling wave after selling wave coursed through that asset class.

What’s more, hedge fund managers continue to struggle, which can trigger liquidation of holdings to raise cash to pay out redemptions. According to a study by the Hennessee Group, hedge funds lost an average of 5.5% in October, marking the fifth consecutive monthly decline. Hedge fund losses are now at 15.3% for the year, putting them on course for their worst showing in history. The only previous yearly loss for hedge funds was back in 2002, when the group lost 1.4%, still far better than the 23% loss recorded for the S&P 500. The worst performing strategies in October were emerging markets and convertible arbitrage, while short sellers were best performers, gaining about 10% compared to a 16% loss in the S&P 500.

Individual small caps on the move were highlighted by Optimer Pharmaceuticals Inc. (Nasdaq:OPTR), which jumped 87% on news that the firm’s antibiotic drug met late-stage trial goals. On the other side of the drug test spectrum, Sangamo BioSciences Inc. (Nasdaq:SGMO) tumbled 66%, gapping lower on unusually heavy volume as a nerve drug failed a mid-stage trial.

From a charting standpoint, the Russell looks bleak but is right on schedule for a potential inverted head-and-shoulders pattern that would fit symmetrically with the previous mid-October lows. If that formation doesn’t pan out then there is very little dynamic support below 462 to stop a hard retest of the lows. Looking toward Wednesday’s session, there is no economic data on tap, leaving the market free to focus on profit numbers, and other issues. If the Russell can stage a bounce, the resistance Wednesday is at 495, 505 and 514.50.