The S&P 500 Index (INDEXSP:.INX) did an excellent job recovering from a small (Federal Reserve/market-misread-induced) consolidation in June. Since the beginning of the year, the Dow Jones Industrial Average (INDEXDJX:.DJI) has led other key indices—that is until recently.
Major stock market indices have been usurped by the stunning performance of the Russell 2000 Index. When small-cap stocks start moving, it’s a powerful signal.
Strength in small-cap stocks reveals a lot of innate aspects in investor sentiment. It means that there is more speculative fervor and willingness on the part of investors to buy less safe names. It also means that the market expects improving business conditions from domestic businesses, as small-cap stocks typically aren’t as global as larger companies.
I’ve noticed a stock market trend over the last couple of quarters. Smaller technology companies have been reporting better financial results. But many of the positions I watch haven’t moved materially on the stock market until only recently. Perhaps there is some correlation to the performance of component companies in the Russell 2000.
Regardless, this index has been very strong over the last three weeks.
In the larger-cap space, many of the stock market’s biggest brand names are reporting decent earnings with mediocre sales growth. Once again, it’s looking like it’s going to be another quarter of one financial metric, either revenues or earnings, coming up short of Wall Street consensus.
The most important thing is stability of operations and meeting or beating one Wall Street estimate. That’s my read on how this stock market feels about the current reporting season.
International Business Machines Corporation (IBM) saw its second-quarter revenues fall, but earnings beat consensus. The company boosted its full-year earnings outlook.
It is very much an environment where large-cap companies continue to struggle with top-line growth.
Typically, small-cap stocks report later than large-caps. These companies don’t have big accounting departments to get the numbers out as quickly as their larger counterparts. With recent strong action in the Russell 2000 index, there is speculation that smaller companies are going to be reporting improving business conditions.
The argument can easily be made that the stock market has already bet on current earnings with the strong performance since January. With that scenario, stocks should be selling off on their earnings news, but this isn’t quite the case. (See “Why Investor Sentiment Is Still Bullish in the Face of Lackluster Economic News.”)
This market is still in a kind of confirmation mode, looking for financial results that show things aren’t coming apart. Optimism in investor sentiment is still very much the result of the Federal Reserve and the stock market playing cat-and-mouse with the consequences of extreme monetary policy.
The stock market wants the Federal Reserve to keep playing the game, recognizing that it must eventually end. It is very much a stalemate until corporate top-line growth takes the lead—if it can.
This article is brought to you courtesy of Mitchell Clark from Profit Confidential.
Related: iShares Russell 2000 Index ETF (NYSEARCA:IWM)