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Smaller American companies are getting crushed in the stock market’s recent wild swings. That could be an ominous sign for the economy.
The Russell 2000 (RUT) index, home to companies like Crocs (CROX), BJ’s Wholesale (BJ) and others with an average market valuation of about $3 billion, is now trading more than 10% below its 52-week high. That means it’s in a so-called correction.
An iShares exchange-traded fund of microcap stocks (IWC) (which are even tinier firms than those in the Russell 2000) is nearly 15% below its peak. So it’s potentially heading into a bear market.
This is troubling because most smaller US firms depend more on the American economy (and US consumers) for their revenue and earnings than the giants of the Dow and S&P 500. They aren’t generating as much revenue and profit from markets around the world.
So the hard times for smaller stocks might be a more accurate barometer of the US financial landscape than what’s happening with big tech companies like Apple (AAPL), Microsoft (MSFT) and Google owner Alphabet (GOOGL) — which have held up much better during the recent market pullback.
“Peel the onion back one layer and there has been a more severe rotation in stocks under the surface,” said Liz Ann Sonders, chief investment strategist at Charles Schwab.
Sonders noted that many of the smaller companies in the S&P 500 beyond the top techs have been prone to big corrections in the past year. It’s just that there are enough “pockets of strength” among the larger firms in the index to mask the broader weakness in the overall market.
This divergence has caught the attention of other strategists on Wall Street too.
David Wright, co-founder of Sierra Mutual Funds, noted in a recent report that far more stocks on the NYSE and Nasdaq have been hitting new 52-week lows rather than highs as of late.
“What this means is that only a few large stocks are holding the indexes up, while an increasing number of stocks are actually in a bear market already,” Wright said.
The market pullback in smaller stocks is a big reason why the CNN Business Fear & Greed Index has suddenly plunged into nearly “extreme fear” territory after registering levels of “extreme greed” just a month ago. The volume of shares in stocks going down is also higher than those going up.
Small companies also may not be able to afford paying higher wages to workers as easily as corporate behemoths. Profit margins (and overall earnings) could take a hit as they try to stay competitive with salaries, bonuses and other compensation.
Meme mania returns?
GameStop (GME) will report earnings after the close Wednesday. The stock, along with movie theater chain AMC (AMC), has become synonymous with the meme stock revolution powered by traders on Reddit and other social media sites.
Shares of GameStop are up more than 850% so far in 2021. But the stock has had an extremely bumpy ride, to put it mildly. GameStop is also trading nearly 65% below the all-time high it hit in January.
It’s easy to forget that GameStop is actually a legitimate business and not just a “stonk” that became a plaything of traders trying to punish short selling hedge funds that were betting against the company.
For what it’s worth, there are growing hopes that the company’s business is turning around under Matt Furlong, the new CEO and former Amazon (AMZN) executive who joined GameStop earlier this year.
GameStop has also made a bigger push into e-commerce since Chewy (CHWY) co-founder Ryan Cohen took a big stake in the company and was subsequently named chairman.
The company is still expected to post a loss for the current quarter. But Wall Street is predicting a profit in the holiday period that ends in January and is forecasting that GameStop will make money in its next fiscal year.
Demand for video games at GameStop should be strong. The bigger challenge could be the widely publicized shortages of Microsoft’s Xbox Series X and Sony’s (SNE) PS5 consoles due to the global supply chain issues impacting semiconductors.
Up next
Monday: Germany factory production
Tuesday: AutoZone (AZO), Toll Brothers (TOL), Stitch Fix (SFIX) earnings
Wednesday: China trade report; Campbell Soup (CPB), Brown-Forman (BFB), GameStop earnings
Thursday: China inflation; US jobless claims; Hormel (HRL), Costco (COST), Broadcom (AVGO), Chewy, Lululemon (LULU) earnings
Friday: US consumer prices; University of Michigan consumer sentiment
