August 9, 2024 | The Stock Market Correction is a Warning Sign

U.S. stock markets crashed from Friday last week through Monday this week. High flying tech stocks cratered as well as the broad indexes like the S&P 500 and Japan’s Nikkei.

Was this a crash of the large-cap technology sector, or does it signal the broader market is entering a bear phase?

On Monday night some headlines screamed “tech wreck” after the 2-day market drop. For many months the hype over artificial intelligence and especially the gains in one stock, Nvidia — almost a ten-bagger since 2022 — led traders to believe that the market was just one sector. But a rumor surfaced last week that Nvidia’s new chip has been delayed and Intel announced massive job cuts.

Prior to this correction, the gains of the Magnificent Seven reinforced a view that a few stocks could provide spectacular gains for the foreseeable future. The Mag 7 are Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla.

We can take an index proxy for the most overweight tech stocks and compare it to a broader index of smaller stocks that are not focused on technology to answer the question about the nature of the market correction.

The Russell 2000 is a sub-index of the broader index called the Russell 3000 which makes up 96 percent of the entire U.S. stock market. The Russell 2000 is an index of the 2000 smallest cap stocks in that total market index.

The SPDR Portfolio S&P 500 Growth Index contains the largest capitalization stocks in the S&P 500 that have the highest growth prospects. The top companies in the SPDR are Apple, Microsoft, Nvidia, Meta, Amazon, Alphabet, Eli Lilly, Broadcom and Tesla. This list includes all of the Magnificent Seven stocks plus Lilly and Broadcom. These largest companies make up almost 60 percent of the SPDR index and technology stocks are about 49 percent.

The 2000 index includes only the smallest companies, at least in comparison to the mega-caps, and is highly diversified among all sectors of the stock market. The largest cap company in the index — Insmed Inc. — is less than $300 million and makes up about 0.46% of the index.

Over the last five years the SPDR has outperformed the Russell 2000 by a wide margin — 91.66 percent versus 36.49 percent.

Source: Bloomberg

But from the intra-day peak reached Friday last week to the trough on Monday of this week the Russell 2000 dropped by approximately 13 percent, about the same as the SPYG.

So, investor concerns are not just about tech, the Mag 7 or the large cap stocks of the S&P 500. The worry is more broadly based, about the resilience of the economy and the effect of the rise in interest rates on a highly indebted public and private sector.

The increase in the unemployment rate to 4.3 percent, from a bottom of 3.4 percent last summer, signals that the U.S. could experience a recession soon. Stock market corrections that occur during recessions are usually more severe than a standard cyclical setback.

Hilliard MacBeth

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Hilliard MacBeth August 9th, 2024

Posted In: Hilliard's Weekend Notebook

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