On the surface, it looked like a decent day for the market. The major indexes were close to flat, small caps outperformed and breadth was solid with around 4,400 stocks advancing and 3,000 declining.
That sounds quite healthy, but if you dig deeper, there was some alarmingly poor action. Sectors such as software, cloud computing and big-cap technology were hit hard. The easiest way to see the extent of damage down to high momentum stocks is to look at the exchange-traded fund, Innovator IBD 50 Fund (FFTY) . These are stocks picked using the Investor's Business Daily methodology, which favors high revenue and earnings-per-share growth, among other factors.
The IBD 50 Fund ended the day down with a loss of 2.98%. If the Dow Jones industrial average had fallen an equivalent amount, it would have lost nearly 800 points. The Dow ended the day with a gain of about 40 points.
The only way this sort of inconsistency can occur is when there is a massive rotation out of one group of stocks into another. Monday the rotation was out of the best-performing stocks and the hottest initial public offerings, which are generally quite expensive, and into the poorest performing stocks that have less aggressive valuations. Stocks in the oil-and-banking sectors were the big beneficiaries Monday.
To add to the complexity of the action, there was no obvious catalyst for the move. There wasn't any specific news to trigger the exodus from the stocks that have been everyone's favorite, other than the fact that everyone already likes them.
The more important issue now is what does this rotation mean? Is this rotation healthy and does it indicate that a new crop of leaders will now emerge or is this a situation where the weakness will expand into the broader market?
I don't know the answer to that, but I do know that this is creating a high level of instability and that it is going to make many market players nervous. They may be inclined to move to the sidelines rather than try to rotate into stocks that have been laggards for a long time. Usually, the stocks that have lagged badly have done so for a reason, and they don't suddenly turn into leading momentum plays.
This is some of the most unusual market action that we have seen in a while, and increased vigilance and defense are paramount.
Have a good evening. I'll see you tomorrow.