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High Flying Stocks Get Hit. Blip, or Winds Changing?

Market Digest – Week Ending 3/28

It was a week of counter-trends. For a change, US stocks were down while international equities gained, with Emerging Markets leading the way. Within the US market, the S&P 500 was down only 0.5%, but small cap stocks finished down more than 3.5%. There was no obvious catalyst for the divergent performance other than a possible fundamental rotation toward market segments with more attractive valuations. In economic news, US Q4 GDP growth was revised to 2.6%, slightly higher than previous estimates. Bonds were flat, while gold fell and oil rose.

Weekly Returns:

S&P 500: 1,858 (-0.5%)
FTSE All-World ex-US: (+2.0%)
US 10 Year Treasury Yield: 2.72% (-0.02%)
Gold: $1,294 (-2.9%)
USD/EUR: $1.376 (-0.2%)

Major Events:

  • Monday – Biotech stocks dropped 3.5%, possibly in relation to a congressional complaint the previous week over Gilead’s pricing of a Hepatitis drug.
  • Monday – The G-7 nations effectively disbanded the larger G-8 by excluding Russia until it changes course in Ukraine. They also agreed to exert punitive sanctions on Russia.
  • Monday – Five former Bernie Madoff employees were found guilty of aiding the fraud.
  • Tuesday – The IRS said it will treat bitcoin and other virtual currencies like property. The rule generally would impose capital-gains taxes, rather than higher regular tax rates on profits, but highlights potential complications in using bitcoin as currency.
  • Wednesday – Microsoft was said to be in plans to release a new version of Office for the iPad.
  • Wednesday – King Digital Entertainment, maker of Candy Cursh Saga, raised $500 million in an IPO, but shares were down 15% on the first day of trading .
  • Wednesday – Citigroup failed a Fed stress test and will not be allowed to continue with plans to raise its dividend or increase stock buybacks.
  • Thursday – US Q4 GDP growth was revised up to 2.6%.
  • Thursday – Ukraine arranged for an $18 billion bailout fund from the IMF.
  • Friday – US officials expressed concern about reports that Russia is massing troops near Ukraine and actively seeking to conceal positions and establish supply lines.

Our Take:

We don’t know what sparked it, but this week featured a noticeable flight out of higher momentum parts of the market into less favored areas. Small cap stocks were down over 3%, Facebook fell 11%, Chipotle, Tesla, Twitter and the iShares biotech ETF each fell 7%. Meanwhile, Emerging Markets rose over 4% and utilities were up over 1%.

There’s no way to predict if this is just a one week counter-trend or the end of the ride for some of these high flyers. It has been a good ride. If you’ve profited riding one of these waves, it may be time to consider at least paring back and taking some profits. Regarding small cap, some exposure almost always makes sense, but be careful if you’ve got more than 40% of your US equity portfolio in small cap stocks. The forward PE on the Russell 2000 (a popular small cap index) sits 19.6, which is pretty rich.

Likewise, if you have been avoiding international, now may be the time to get more broadly diversified. To figure out how that might apply to your own portfolio, check out the Daily Capital post How Much International Exposure Should You Have? As a bull market matures, it gets even harder to be successful making big bets on single stocks or narrow segments of the market. This bull will likely run further, but it is not young and virile. The later stages of a bull market are a great time to have a well-diversified, boring portfolio.

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