Volatile day ends with mild dip for small caps

Kevin Pendley | Sep 02, 2008 4:34pm EDT | Comment

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Small-cap stocks turned lower Tuesday, rejecting an impressive morning rally as financial and tech stocks failed to gain traction even with the benefit of a sharp pullback in crude oil prices. The Russell 2000 (NYSE:IWM) closed down 0.99, or 0.13%, at 738.51. For the year, the Russell is down 3.5%, which is quite a shift from the morning rally when the Russell looked poised to post one of the highest daily settlements of the year. The selling pot was stirred among large caps too, with the Dow slipping 0.2% on the day; the Dow is now down 13.1% for the year. In addition, the S&P 500 lost 0.4% Tuesday and is off 13% for 2008.

The dramatic reversal in fortune for stocks today left a mild bearish reversal formation on daily charts as the Russell closed lower after threatening to challenge move highs in the morning. In addition, when a market sinks in the face of seemingly bullish news, it is often considered a classic signal that something else is wrong. In this case, the market seems to be saying that a little relief at the gas pump isn’t enough to fix what ails the economy or the credit crisis.

It’s interesting to note too that the erosion in stocks seemed to coincide with a surge in Treasury markets. The yield on the benchmark 10-year note tumbled nearly 2% to the lowest closing level since late April. Yields move inversely to price, which means that demand for Treasury products (a traditional safe-haven) was strong today. Some of that push for a safety net seemed to move in tandem with the Fitch downgrade of paper debt for mortgage lending giants Fannie Mae (NYSE:FNM) and Freddie Mac (NYSE:FRE). If there were concerns in the market about the government-sponsored enterprises, they didn’t really show up in the stock, as shares in FNM rose 8%, while FRE jumped 14%.

The day dawned brightly for equities as investors embraced a huge slide in crude oil prices. Even though the stock market turned lower in the afternoon, crude oil prices still lost about 5% on the day, sinking $5.75 a barrel to $109.71. The stiff decline in energy prices was accompanied by a big rally in the U.S. dollar, and a whole host of commodity markets succumbed to the pressure — all of which would seem to be bullish for stocks. So, crude oil was down 5%, the Commodity Research Bureau Index lost 3.3%, the greenback rallied 0.7% against the euro to seven-month highs and yet stocks were lower.

Lost in the mad shuffle on stocks today was the ISM Manufacturing Survey, which is usually a fairly big event on the radar screen. The headline figure came in at 49.9%, which was above the forecast of 49.5%, but still below the 50.0% contraction zone. Of greater significance might be the new orders index, which rose to 48.3% from 45.0%, but which has now been below 50.0% for nine consecutive months. “Going back in time, the economy has been in a recession when the new orders index held below 50.0 for an extended period,” Asha Bangalore, economist with Northern Trust, wrote in an email report. “If history is our guide, it appears that the new orders index from the ISM survey is sending an important message,” she said.

The economic calendar will continue to pick up steam this week, culminating with Friday’s big monthly employment release. On tap for Wednesday is the factory orders report, the beige book afternoon report and vehicle sales throughout the day. In addition, Federal Reserve Bank of Boston President Eric Rosengren will talk about the economy in the midday time frame.

While tech stocks were leaking oil today and financials were unable to pick up the baton, commodity names were getting sand kicked in their face, which was a significant drag on the index products. The biggest sector losers today were coal, steel, metals and mining, oil exploration, oil refining, oil and gas storage, aluminum and fertilizer. On the upside, gains were registered in home improvement retail stocks, hotels, tire and rubber, office electronics, regional banks, general merchandise stores, department stores and restaurants. Clearly, retailers, hotels and restaurants were happy to see the decline in crude oil, hoping that consumers would redirect some funds from the gas tank to other endeavors. The S&P Retail Index gained 2.9% for the day, holding in the green despite the overall market failure.

Another area of strength came from airline stocks, with the AMEX Airline Index rising 6.5%. Within the air carrier group, small-cap stock US Airways Group Inc. (NYSE:LCC) rising 3.4% and Alaska Air Group Inc. (NYSE:ALK) up 4%.

Individual small-cap stocks of note included Sciele Pharma Inc. (Nasdaq:SCRX), which gapped higher and soared 58% on unusually heavy volume on news that the firm would be bought for $1.1 billion by Japanese firm Shionogi & Co. West Marine Inc. (Nasdaq:WMAR), rose 20% to the highest point since April and International Shipholding Corp. (NYSE:ISH) jumped nearly 18% on news that the firm would be acquired for $25.75 a share. On the downside, James River Coal Co. (Nasdaq:JRCC) gapped lower and shed about 13% in tune with the commodity market freefall today. Along similar lines, China Sunergy Co. Ltd. (Nasdaq:CSUN) tumbled 12%.

Looking at the chart picture, today’s failure left a troubling reversal on daily charts. Still, the market should find support on dips near 726 and then the key test is along 720.50. A breach of the latter point would suggest that an intermediate top has been forged and would carry an immediate downside target into the 690 zone. Any move back above 750 this week would help dull the bearish reversal action from today’s slide.