A flight to quality should not be reserved for large caps

Key points to remember:

  • Netflix pushes the Nasdaq deeper into correction territory and weighs on the S&P 500
  • The VIX flirts with 30, which was often a turning point in 2021
  • A flight to quality should not be reserved for large and mega-caps

After Thursday’s close, Netflix (NFLX) reported better-than-expected earnings but forecast major slowdowns in subscription growth. The stock immediately fell after hours, which translated into the next day. NFLX fell over $100 per share and closed down 21.79% on the day. The announcement was felt across the entire Nasdaq Composite ($COMP), which fell 2.72% and breached another level of support. The index fell further into correction territory and is now 13% off its all-time high. The next major support level for the Nasdaq is around 13,000. If the index falls that far, it would be approaching bear market territory, as it would be down 20% from all-time highs.

Of course, the Nasdaq wasn’t the only clue to hit the news. The S&P 500 (SPX) fell 0.75%, with Materials, Consumer Discretionary and Financials leading the way lower. Ecolab (ECL) was the worst performing stock in the materials sector of the S&P 500, down 8.48%. ECL is a world leader in water, hygiene and deterrent products. He announced a 12% price increase worldwide. Rising prices could hurt the company’s sales, likely driving the stock down.

Top influencers on the S&P 500 and Nasdaq include stocks like Amazon (AMZN), which fell 5.95%, Apple (AAPL), which fell 1.28%, Microsoft (MSFT), which traded down 1.85%, Meta (FB), which fell 4.23%, and Alphabet (GOOGL), which closed down 2.22% on the day. AMZN and FB are down more than 20% from their 52-week highs. AAPL, MSFT and GOOGL are not down as much, but still 10% to 13% below their highs. These stocks along with Netflix, which is down more than 40% from its all-time high, weigh heavily on these indexes due to their sheer size.

As expected on a down day, defensive sectors including consumer staples, real estate and utilities were the best performers and the only sectors to close in the green. Bonds also rose as the 10-year Treasury yield (TNX) fell back to support around the 1.75% level.

The VIX (Cboe Market Volatility Index) flirted with 30 throughout the day, reflecting mounting fear among investors. However, in an odd twist, over the past year the 30 level has often signaled the end of a selloff. Some selloffs or corrections were correlated with a VIX as high as 37, so this development may be something to watch. At this point, we could start to see investors trying to hit market lows next week. They will be looking to buy potential bargains. For example, on Friday, investors were already buying stocks like Peloton (PTON) and McDonald’s (MCD), which are a few stocks that have recently been beaten by investors. This type of buying could signal that the pendulum has swung too far in one direction.

Drift towards quality

When markets turn bearish, there is often a “flight to quality” as investors sell riskier small-cap stocks in favor of blue-chip large-cap stocks. Investors are selling small-cap stocks, with the Russell 2000 (RUT) falling another 1.20% on Friday and adding to its four-day losing streak. While a 7.5% drop this week is not to be overlooked, it is not the panic selling expected in a bear market when investors are avoiding risk.

In fact, the S&P 600 Small Cap Index tracks 600 “higher quality” small cap stocks, and it actually trades in line with the S&P 500. Of course, both indices have fallen recently, but quality may be in small-cap as well as large-cap stocks. Like the S&P 500, the S&P 600 saw strength in the energy and financials sectors, but weakness in the information and communication technologies.

So while the lack of magnitude signaled by the fall of the Russell 2000 is still a concern, this is a stock picker’s market. In my January Outlook article, I warned that this could be the year of the active fund manager as investors need to look for quality. Unfortunately, quality flights cost a bit more, in time for research and analysis.

Sell ​​to close

It’s been a brutal last hour of trading this week for stocks, which makes you glad it’s a shortened holiday week. However, traders often view last-hour sell-offs as a bad sign for stocks the next trading day. Traders often pick up the next day where other traders left off the day before. However, there is no guarantee that selling at the close one day means the stock will sell the next day. While that might mean something to a day trader, for many investors selling at the close goes unnoticed.

Friday’s sell-off was complicated by options expiration, which is usually a volatile day for stocks anyway. January expirations have a bit more “umph” due to the expiration of LEAPS options (long-term equity anticipation securities). The following Monday after expiration often has some residual volatility also due to expiration related consequences such as stock allocation.

TD Ameritrade® Commentary for educational purposes only. SIPC member.

Comments are closed.