Small caps bleed red
Small-cap stocks reversed course Friday, erasing much of the steep gains from Thursday as monthly employment data served up a shocking rise in the jobless rate and crude oil prices exploded to new record highs. The Russell 2000 (NYSE:IWM) shed 22.90, or 3%, to 740.37, ending a volatile week in dizzying fashion. The abrupt decline Friday registered the largest one-day percentage loss since March 6, and marked just the fourth time this year that small caps tumbled 3% in one day.
One could argue that today’s morning setup brewed up a “perfect storm” for stock market declines. Equities came into the session ripe for a bad news surprise following an overdone rally Thursday, and when the unemployment rate shockingly rose to 3½-year highs, it triggered a rout on the U.S. dollar, which in turn fueled a dramatic surge in crude oil prices.
“I think today’s decline was a combination of negative factors: we took out the short base during Thursday’s rally, the jump in oil is negative for the economy via poor growth and inflation, there are rumors of Israel attacking Iran and the labor market is weak,” said Nick Kalivas, vice president of financial research with MF Global, in an email interview with SmallCapInvestor.com.
Today’s monthly employment report showed a baffling jump in unemployment to 5.5%, way beyond the median forecast for a mild rise to 5.1% from 5% the previous month. In fact, the last time the unemployment rate jumped 0.5% in one month took place 22 years ago. Data spin doctors explained away the rise as a sudden surge in college and high school students out looking for summer jobs, or as the number series simply “catching up” with the weak job picture. While the summer job explanation plays well, it’s worth noting that this data is seasonally adjusted, and it’s not as if we’ve never had college kids looking for work in May before. However, some economists cautioned that collection time-frame quirks this go around may have moved a bunch of the summer job crowd up into the May report from June. If so, then a dip in the jobless rate should be seen in next month’s employment data.
“The labor market is under severe stress, firms have stopped expanding payrolls, (there is) no ambiguity here,” Asha Bangalore, economist with Northern Trust, said in an email. “The National Bureau of Economic Research could take several more months to declare an official onset of a recession, but there is no doubt the U.S. economy is experiencing one. The Fed will not raise the federal funds rate until the unemployment rate falls, [but] the unemployment rate has not even peaked yet, so considerations of a higher federal funds rate by year-end appear far-fetched,” Bangalore said.
Unfortunately for the bulls, the market wasn’t faced with just coming to grips with the jobs report. Crude oil prices went absolutely ballistic the last two days, soaring some $14 dollars a barrel to new record highs above $138. Morgan Stanley analysts predicted crude oil prices could be at $150 by the July 4 Independence holiday, which would further crimp consumer discretionary spending funds. It seemed particularly chilling that crude oil options traders were making a market for $200 crude for the September delivery period.
The dramatic move in crude oil prices wasn’t the only commodity market making a run either. A huge rout in the U.S. dollar sparked a bullish wave throughout physical markets. Corn prices hit an all-time high above $7 dollars a bushel, spot gold shot up some $20 dollars an ounce and the Commodity Research Bureau Index of 19 markets climbed to a record peak. The dollar tumbled 1.1% against the euro and about 0.75% versus the yen, fueling the psychology behind the long commodity/short dollar trade.
From a broad sector standpoint, coal, gold and energy stocks were the only sectors able to find buyers during Friday’s downside press. The worst performers were homebuilders, thrifts and mortgages, casinos and banks.
As for individual small caps, GeoResources Inc. (Nasdaq:GEOI) slumped about 18%, gapping lower after announcing plans to sell stock in a private offer. Calamos Asset Management (Nasdaq:CLMS) tumbled over 15% without any apparent fresh news behind the slide. However, the stock did climb to the highest levels since January on Thursday. Sangamo BioSciences Inc. (Nasdaq:SGMO) fell nearly 15% on news that the company will move into a second phase for a trial to treat diabetic neuropathy. On the upside, Inspire Pharmaceuticals (Nasdaq:ISPH) jumped some 36% on unusually brisk volume after the firm said its cystic fibrosis trial went well.
Despite the obvious negative tilt to Friday’s action in equities, small caps still carved out six-month closing highs earlier this week on daily charts, and remain in the shadow of long-term highs while the Dow and S&P 500 failed to challenge the recent highs. Even the decline Friday was just slightly more severe in the large-cap products than in the Russell 2000.
“I actually think the strength in small caps relative to large caps is negative,” Kalivas said. “The divergence between the major indices is not healthy. The NDX and small caps have been strong, but the Dow and S&P 500 [have been] weak. This is the type of stuff which can occur at short- and long-term tops,” he said.
Examining the rollercoaster activity at the tail-end of this week, one crusty 25-year trading veteran termed the rally Thursday as a classic instance of “purging the shorts and sucking in the sheep,” meaning that the rally to six-month closing highs in small caps was magnified by the shorts tossing in the towel ahead of the jobs report, while new longs were seduced into the market on the highs ahead of the big employment release, fearing they would be left behind at the station. From either side of that argument, it would be a punishing close to a volatile, interesting week for stocks.
Looking ahead to next week’s action, the market will get a chance to react to retail sales on Thursday and CPI Friday. “I think stocks [will] probably trade lower next week,” Kalivas said. He noted that if the S&P 500 stays below 1370, it will set up for another leg down. “The oil market is a wild card, but I think the weakness in payrolls pushes out the timeline for hopes of an economic recovery,” he said.
