Back in late 2021, I spent a considerable amount of time discussing how a few big-cap technology stocks were covering up extremely poor action in the majority of stocks. The folks in the business media were discussing this great market because they failed to look beyond the indexes that are primarily driven by a few large-cap names.
The major flaw in the indexes is that they are capitalization weighted. For example, Apple (AAPL) has a weight of a bit more than 14% in the Nasdaq 100 (QQQ) , and Microsoft (MSFT) is about 10%. Those two stocks are nearly 25% of the entire index and offset more than 80 other stocks.
The same thing holds in the S&P 500 to a lesser extent, and the DJIA is even worse because it uses price weighting. The stock that moves the DJIA more than any other is UnitedHealth Group (UNH) which has a nearly 10% weight because, at $479.62, it has the highest price. JPMorgan Chase (JPM) has a slightly smaller market cap but only a 2.5% weighting because its price is lower.
That is a long-winded explanation of why the indexes are often a very poor measure of what is really going on in the markets. Currently, we are seeing one of the most extreme disconnects between the QQQ and iShares Russell 2000 ETF (IWM) that has existed for decades. Here it is in graphical form.
Eventually, this sort of disconnection will close, but the big issue is how the gap decreases. Back in early 2022, it took place when the big-caps finally broke down, while some of the worst stocks did not drop as much. There continued to be very broad weakness under the surface, but the big-cap stocks began to have slightly greater relative weakness, and that closed the gap.
We are at a point now where this issue will be confronted again. Will the gap between these big-caps and small-caps close by greater weakness in the most popular big-cap names, or will the small-caps start enjoying some relative strength?
My Stock of the Week is small-cap Hims & Hers Health (HIMS) that saw its revenue nearly double last quarter but is currently struggling with the poor action in small-caps. I'm looking to slowly add to it as it tests support levels.
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