Stop Freaking Out: Nasdaq 100 versus Russell 2000

August 8, 2014 8:56 AM

World equity markets are under a lot of stress right now.  We’ve said it before and we’ll say it again – the list of potential negatives for markets is seemingly longer now than it has been a quite a long time.  That may be perception over reality, but in trading, it is often perception which matters more than factual hindsight.  The headwinds that markets are facing include: geopolitics and war, structural economic problems in Europe and Japan, Chinese leverage and monetary mismanagement, domestic political policy risks and above all, the risk that Federal Reserve policy will mismatch market expectations. 

There are a whole host of other policy, political and market risks hitting investors squarely in the face today.  One of those issues is the mental scar tissue remaining from the Great Financial Collapse of 2008 and 2009 when almost every retail investor suffered giant portfolio losses.  It has been easy to stay invested over the past two years, but the tendency to sell quickly in the face of an overwhelming list of market negatives remains a lingering psychological component of this market.  Again, we have said previously that this is a “high conviction” type of market where investments made with the highest level of conviction are what should be in focus rather than trying to be temporarily clever.  That means longer term thematic and heavily analyzed trades via an old fashioned bottom up approach should be the core of any portfolio. 

The question at hand is whether the announcement of further US involvement in Iraq warrants the type of selloff we have seen overnight?  At writing, US equity futures have already bounced back from their lows and Spanish and Italian equities are in the green or close to it.  We think this market could be in for a some summer doldrums (a slow burn lower… http://constantvoyagermacro.tumblr.com/post/93801622008/macro-monitor-8-4-14-a-slow-burn-for-stocks ) but wonder if this selling, ostensibly because the US has shipped 70 plus aid packages to Iraq’s northern areas, has special forces on the ground and has agreed to “help” the Iraqi Air Force target ISIS militants, is warranted.  Out of all of the risks out there, this one strikes us as somewhat less market-centric.  That is, the markets have kind of ignored Euro deflation yet freak out when the US has a limited military involvement in a country that we are certainly not going back into absent a completely different turn of events?  Cheap just got cheaper and expensive a bit cheaper too, but this is not a simple buy-the-dip market.  Remember, it is high conviction time out there.

One trade that may fit into several risk parameters for new US equity exposure is long of the Nasdaq 100 ( $^NDX ) and short of the Russell 2000 ( $^RUT ).  Owning the biggest and best US technology companies like Apple ( $AAPL ), Oracle ( $ORCL ), Google ( $GOOG ), and some of the stodgier, older technology names that verge on a value versus growth trades like Microsoft ( $MSFT ) and Cisco Systems ( $CSCO ) is a good place to hide out from further market downturns.  These companies all just got a bit cheaper yesterday and index exposure may be an attractive way to own additional exposures to these types of assets, especially as the IT sector reports very good Q2 2014 earnings.  So far, over 80% of IT companies have reported earnings above estimates for Q2 2014. 

On the other hand, the Russell 2000 is expensive and has been for some time.  Fanatical believers in an American growth economy can defend the Russell at these levels and it is true that over the longer term, the “small stock effect” still matters.  Still, with a trailing P/E ratio of 65 which is much higher than the year earlier level of 49, the Russell is filled with many story stocks that may not meet the idea of high conviction positions.  In addition, a higher level of volatility across markets and assets is likely to be worse for the Russell 2000 as overly optimistic positions get flushed out thanks to Iraq, the Federal Reserve and Vladimir Putin.

DISCLAIMER: NOTHING HEREIN SHALL BE CONSTRUED AS INVESTMENT ADVICE, A RECOMMENDATION OR SOLICITATION TO BUY OR SELL ANY SECURITY. PAST PERFORMANCE DOES NOT NECESSARILY PREDICT FUTURE RESULTS.  SEEK THE ADVICE OF AN INVESTMENT MANAGER, LAWYER AND ACCOUNTANT BEFORE YOU INVEST. DON’T RELY ON ANYTHING HEREIN.  DO YOUR OWN HOMEWORK.  THIS IS NOT A RESEARCH REPORT. THIS IS FOR ENTERTAINMENT PURPOSES ONLY AND DOES NOT CONSIDER THE SUITABILITY OR INVESTMENT NEEDS OF ANY INDIVIDUAL.

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