Sunday, July 27, 2008

Mid Cap and Small Cap Stocks: Looking Resilient




Three charts from one of my favorite data sources, Decision Point, show the market performance for S&P 500 large caps (top chart); S&P 400 mid caps (middle chart); and S&P 600 small caps (bottom chart). The index performance is in the top pane of each chart, and the advance-decline lines specific to the stocks in those groups appears in the bottom panes.

What we can readily appreciate is that this recent bout of market weakness has been dominated by the large caps thanks, most likely, to the influence of large financial and housing-related shares. We made significant bear market lows in the large caps, but note that the mid caps never moved below their March lows. Small caps made a stab a new lows and quickly pulled back into their range.

Since the lows of earlier this month, moreover, small caps have led the bounce. They have recovered nearly half of their recent decline before pulling back late in the week. The bounces in the mid caps and in the large caps have been far less robust--something that is evident by examining the advance-decline lines.

The above view suggests that there are many segments of the equity market that have not been in panic mode. Indeed, if you had asked me a year or two ago where these indexes would be if we had $4.00/gallon oil, a historically weak dollar, prominent bank failures, a need to bail out the GSEs, and housing values falling 20% per year in many markets, I would have expected far lower levels than we're seeing now. That doesn't mean we can't go lower, and it doesn't mean that systemic problems in the financial sector couldn't drag everything down, from small cap to large.

Still, however, with all that has gone wrong, we are holding well above the 2002 and 2003 lows, with smaller stocks particularly resilient. Back in the early 1980s, we had one scary headline after another: steep inflation, high interest rates, savings and loan institutions going under, and a market that had been significantly lower over the prior 10 years in real terms. That market stubbornly held above the 1974 lows in what we now see in retrospect as a long-term bottoming. The inability to make new lows when all the news is bad is one characteristic of such bottoming. That process can take a while, as in the late 1970s and early 80s, but it eventually poses unique opportunities for those with long time horizons, patience, and cash.
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