Don’t Let the S&P 500 Mislead You About Market Health
There is significant damage under the surface in AI, growth names, and small-caps.
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The stock market is undergoing its most severe corrective action since the Liberation Day tariff scare back in April. Given the rally's magnitude since then, the correction remains relatively minor, with the S&P 500 only 2.8% below its all-time high. But beneath the surface, some of the damage is much worse.
The primary problem is that investors are now questioning valuation in the AI sector. There are doubts that the massive infrastructure spending will deliver the returns that have been priced into many stocks, especially the hyperscalers.
The fallout in the AI sector spills over into growth stocks in general. While the S&P 500 was down only about 1% Thursday, the Innovator IBD 50 ETF (FFTY) took a 5.4% hit and is more than 10% below its recent highs. The IBD 50 ETF is a proxy for growth stocks and includes high-flying names such as Advanced Micro Devices (AMD) , American Superconductor (AMSC) , and IREN Ltd. (IREN) .
The Russell 2000 (IWM) small-cap index is also lagging. It breached its 50-day simple moving average on Thursday, sinking 1.8%. The group had been enjoying a run of relative strength, but trouble in the biotechnology sector hit, and now many of the hottest speculative names have turned sharply lower.
The big question now is how deep this correction might run. The dip buyers that jumped in on Wednesday were trapped and suffered some of the most severe pain since the bottom back in April. They may now be a little gun shy, especially as the government shutdown lingers and skepticism builds about AI valuations.
The good news is that this sort of corrective action eventually creates opportunities, as many quality stocks are sold amid pressure on indexes and ETFs. Strong fundamentals are ignored when there is broad selling, which can lead to mispricing. However, it is challenging to time entries in these stocks because the market pressure can go much further than seems reasonable.
My game plan is to dig into the recent wreckage and find names that have suffered despite strong earnings and reasonable valuations. When the market rallies, these should be the names that recover the best. There are many smaller stocks with good reports that have been sold due to market conditions. I’ll be working on prioritizing the ones I like best and refining a shopping list.
Selling pressure is picking up, and the Nasdaq 100 (QQQ) is at overnight lows about three hours before the open.
At the time of publication, Rev Shark had no positions in any securities mentioned.
