Major Indexes Are Hiding the True Action in This Market
The indices aren’t telling you what is really happening.
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The major stock market indices — the Dow Jones Industrial Average (DIA) , S&P 500 (SPY) , Nasdaq Composite (^COMPX) , and Nasdaq 100 (QQQ) — are used by the business media as a simple, convenient way to describe what is happening in the stock market. Most of the time, there is a reasonable correlation between index performance and the average stock's action. However, there are also periods when the indices are deeply misleading about what is happening beneath the surface.
Wednesday was one of those days.
I have never liked the market’s excessive focus on the major indices because it blinds investors and traders to the many opportunities in individual stocks. On Wednesday, more than 59% of stocks posted positive price action even though all four major indices finished the day in negative territory.
The Nasdaq 100 was the worst performer, falling 1.07%, while the S&P 500 declined 0.54%.
Small Caps Are Telling a Very Different Story
Those losses stand in sharp contrast to the Russell 2000 (IWM) , the small-cap index, which gained 0.62% on the day.
It does not take a genius to understand what is happening. Investors are selling the mega-cap stocks that dominate the major indices and rotating capital into smaller stocks that carry far less index weight. With the exception of the Dow Jones Industrial Average, all of the major indices are capitalization weighted, meaning the largest stocks exert an outsized influence on performance.
Five Stocks Control the Tape
Just five stocks — Nvidia (NVDA) , Apple (AAPL) , Microsoft (MSFT) , Alphabet (GOOGL) and Amazon (AMZN) — account for roughly 35% of the Nasdaq 100 and approximately 28% of the S&P 500. Their movement can easily overwhelm the price action of thousands of smaller stocks across the market.
When those names come under pressure, the indices look weak even if the majority of stocks are acting well.
A Powerful Rotation Is Underway
If you focus only on the senior indices, it is easy to miss the very powerful rotation taking place out of the large-cap stocks that have been the market’s go-to names for the past several years. The Magnificent Seven was the preferred way to gain exposure to the artificial intelligence theme, but that trade has lost momentum and has been lagging for some time.
The rotational action accelerated on Wednesday, with capital flowing into many smaller companies that conservative investors may not even be familiar with.
This Is a Stock Picker’s Market
The good news is that this is an excellent market for stock pickers. You cannot simply buy an index and expect to achieve superior performance. To capture meaningful upside, you need to own individual stocks.
Many smaller companies remain attractively valued and are not wildly extended. While the Russell 2000 will likely need a period of consolidation before long, there is still substantial opportunity beneath the surface.
A Healthy Deflation, Not a Collapse
The bears have been warning for some time about a potential bubble in artificial intelligence. I am not convinced that the bubble is deflating, but if it is, it is happening in a healthy and orderly way. Importantly, it is not dragging down the rest of the market. When the internet bubble burst in 2000, nearly everything went down together. That is not what we are seeing today.
Staying Focused on What Matters
I will continue to focus on individual stock selection and keep digging for new ideas.
Have a good evening. I will see you tomorrow.
At the time of publication, DePorre was long NVDA, GOOGL and AMZN.
