Small caps finish off historic down month with a four-day rally
In an ironic twist, small-cap stocks finished off one of the worst months in history with a four-day rally fueled by improving credit conditions, month-end bargain hunting and a willingness by investors to look beyond current weak economic fundamentals. The Russell 2000 (NYSE:IWM) closed up 23.32, or 4.53% at 537.49 and is now down 30% for the year. The Dow is down 30% for 2008, while the S&P 500 is off 34%.
Central bank officials around the globe slashed interest rates this week (and more are expected next week as well) and the inter-bank lending rate continued to slip lower, suggesting that banks are now more comfortable and trusting and that perhaps the worst of the credit crisis for financial firms is in the rear-view mirror. The Libor rate has declined 14 consecutive trading sessions, tumbling from more than 5% to 3%, spurring hope that various central bank rate cuts and federal bail-out packages have helped unclog credit lines.
Financial stocks played a key role in the rally today, after lagging on some bounce attempts earlier in the week. The Financial Select Sector SPDR Fund rose 3.3%. Large-capper JPMorgan Chase and Co. (NYSE:JPM) rallied 6% as the firm said it would restructure procedures for some $110 billion in mortgages and would halt foreclosure actions. Small- and mid-cap banks and financial institutions were noted all along the top percentage movers today on various exchanges.
Stocks also received a lift from asset allocation trades out of Treasury markets and into equities, Nick Kalivas, vice president of financial research with MF Global, said in an email.
“Regional small-cap banks performed well today,” Kalivas said. “I think easing credit tensions helped. REITS also traded strongly today. Vornado (NYSE:VNO) boosted its dividend and it helped the entire sector while giving some confidence to investors.” Kalivas also said that it has been common for small caps to trade at the turn of the month, which is tied to technical issues and fund flows.
There is a long history of major market bottoms in October, and it will be interesting to see if the rally this week will continue to have traction next week. It would inspire confidence to see the market sustain upside momentum through not only the U.S. presidential election Tuesday, but also to ensure that this bounce wasn’t just month-end window-dressing.
Since we just finished one of the worst months in history, here’s a glimpse at how some of the broad market sectors performed in October (there were no noteworthy sectors in the plus column):
• Industrial REITS (down 66%)
• Automobile Manufacturers (down 52%)
• Aluminum (down 49%)
• Metals and Mining (down 46%)
• Life Health Insurance (down 44%)
• Building Products (down 43%)
• Tires and Rubber (down 42%)
• Auto Parts (down 41%)
• Retail REITS (down 40%)
• Tobacco (down 6%)
• Brewers (down 5%)
• Regional Banks (down 5%)
It’s actually interesting that more energy and commodity groups aren’t on that list, although I suspect it has much to do with the way the S&P sector groups are put together. For instance, the Energy Select Sector SPDR Fund tumbled 17% in October. For much of today’s action, energy shares were lagging the move, but they mounted a comeback in the afternoon. Crude oil prices also staged a rally in the final 30 minutes of trading today, but gains in the commodity arena were hampered by a firm tone in the U.S. dollar, which gained about 1.3% against the euro.
A fresh batch of second-tier economic reports this morning failed to scare off the buyers. For the most part, the data was weak – but in line with expectations. A notable exception was the Chicago Purchasing Manager’s Survey, which slumped to 37.8, way off the forecast of 48.3. There is a sentiment right now from many investors that they are willing to grit their teeth through another couple of months of awful economic data on the perception that the news has already been priced into the market via the September-October collapse. However, next week’s economic calendar serves up some heavier hitting reports (including the big monthly employment release Friday), so if the numbers are a downside shock, it might be difficult to retain confidence.
“Next week’s macro data is likely to be stock bearish,” Kalivas said. “The clear surprise would be stable or improved data. I think the ability to find support on breaks created by adverse ISM numbers, chain stores sales, auto sales and the employment report will say a lot about direction in the end of the year. If the base can hold, stocks have a good chance of extending the recovery,” he said.
“I think much of the liquidation is behind the market, but retail investors will be slow to get back into the market and many hedge fund types are still redemption or sorting out their businesses. They are probably in the 8th inning of liquidation, but the money will not be put back to work quickly. I think rallies are likely to come from a lack of selling as opposed to heavy buying,” Kalivas said.
Individual small caps of note today included SM&A (Nasdaq:WINS), which jumped 126% on news that the firm will be purchased by Odyssey Investment Partners for $6.25 a share. Sonic Automotive Inc. (NYSE:SAH) jumped 29% and the stock has nearly tripled off the lows from Monday. Hungarian Telephone and Cable Corp. (AMEX:HTC) rallied 29%, also trying to make a comeback from 52-week lows set earlier this week when emerging market assets were getting clobbered.
The chart structure for the Russell 2000 carries some significant bottoming signals on daily charts, including a powerful bullish outside reversal rejection of the bear market lows set Tuesday. From a short-term perspective, the market faces solid resistance approaching 546 up to 550 next week, an area that turned back the first bounce off fresh lows a couple of weeks ago.
