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“Mercy to the guilty is cruelty to the innocent.” – Adam Smith
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The fun couldn’t last forever, could it? Futures are sharply lower this morning with tech leading the way to the downside as the Nasdaq is indicated to open 1.5% lower. S&P 500 futures aren’t faring much better with an indicated decline of 1%, but the Russell 2000, while lower is down a more respectable 0.40%.
There are two catalysts for this morning’s weakness. First, Bloomberg reported that the Biden Administration is considering tighter trade restrictions on companies that provide chips with US-based technology to China. On the other side of the aisle, former President Trump told Bloomberg that Taiwan should pay the United States for providing defense of the country against China. If there’s one thing both Biden and Trump can agree on, it appears that China is the issue.
Normally, the impact of these types of headlines isn’t long-lasting, but in this case, we would note that semis have been underperforming the broader market for the last couple of weeks now, so that’s something to watch.
It’s a busy morning for economic data as well. At 8:30 we got the release of June Building Permits and Housing Starts, and then at 9:15, we’ll get Industrial Production and Capacity Utilization. Today’s housing-related data was important from an economic perspective as each of the last three reports on Building Permits and Housing Starts have all come in weaker than expected and in some cases by a wide margin. This morning’s release provided some relief as both headline readings came in moderately better than expected while last month’s readings were revised higher.
After a five-day rally of more than 11%, the Russell 2000 closed 4.42 standard deviations above its 50-day moving average yesterday. Yesterday’s close was the most overbought level for the small-cap benchmark index since…Ever. The prior record was 3.72 standard deviations on 6/27/23 and before that 3.40 standard deviations in January 1991.
Looking at the chart of the Russell 2000’s daily OB/OS reading, you’ll notice that three of the four most overbought daily readings have all occurred since November 2021. One potential explanation for this phenomenon could be that as the overall market has become much more concentrated at the top, the rest of the market has become smaller and more prone to extreme moves. It was only a couple of years ago when we marveled that the largest company in the S&P 500 was larger than the entire Russell 2000 small-cap index. Before yesterday, though, the Russell 2000 still had a market cap of less than $3 trillion which was less than the market caps of Microsoft (MSFT), Apple (AAPL), and Nvidia (NVDA). Therefore, a 3% shift in the market cap of just those three companies would translate into a 10%+ rally for the Russell 2000!
Not only was yesterday’s close for the Russell 2000, the highest in its history, but of the four major US indices (S&P 500, Nasdaq, DJIA, and Russell 2000), it was the most overbought closing level on record.
Starting with the Nasdaq, in its history dating back to 1971, the most overbought reading based on standard deviations above the 50-DMA was 3.59 in November 1991.
The S&P 500 dates back to 1928, and its most overbought reading on record was 4.06 standard deviations above the 50-DMA on 8/3/1984.
The Dow goes back even further than the S&P 500, and while the chart below only extends back to 1928, since 1900, its most overbought reading on record was 4.36 standard deviations above the 50-DMA also on 8/3/1984.