We’re in a Small Capped Bear Market

Back in 2011, all of you thought the market was going back to the 2009 lows. I know this because I was here, dealing with the comments from crazy men typing furiously into keyboards. The market was unhinged heading into October of 2011, just like now. Then the rally happened.

I was 70% cash heading into October and had successfully navigated the correction. Then I stepped in.

I allocated 35% of my cash today, buying WNR, CLF, DECK and TEX. This is what I call “buying the blood” and it never feels right until it does.

Shortly thereafter, PANDEMONIUM BROKE LOOSE (extra Hulk Hogan)

Today over 500 stocks gapped higher by 10% or more. That’s ridiculous. 99% of those gains occurred in the final hour of trade. It’s not possible for this to occur, unless the buying was automated by some magical genie in a server rack. If you are short stocks here or long FAZ, you stand the chance to go from up nicely to negative $1 billion within minutes.

How negative was the mood just a week prior? Have a look.

INSANE S&P LOSING STREAK

Ever since May, the S&P has been down. With September’s 5.5% decline, followed by the 5.5% decline in August, we are now down for 5 consecutive months. The last time we had losing streaks like this was in 2002 and 2008 to 2009. In both cases, it led to a monstrous rally. Although I am bearish as a hairy human living alone in the woods, I need to be on guard (no Jerry) for an 8% rally in October.

 

The market has been grinding lower, led by the absolute destruction of basic materials, financials and tech shares. The leaders have been killed and people have pigeon holed themselves inside 80 year old man stocks. Coupled with the glaring fact that everyone is bearish, Zerohedge’s popularity is at an all-time high and I am 90% out of the market, something is astray, if I might so bold as to say so.

 

This just dawned on me, as I was doing some reading, thinking about the future. When thinking about stocks, I always lay out scenarios that might play out, then try to support them with historical precedence or hard facts.

 

The reality is, we are down 5 straight months and the news is as bad as it gets. Despite the bad news, we haven’t cracked lower. Instead, we are meandering around, grinding swing/momo traders into dust.

 

The real negative developments, aside from Europe, is the deterioration of China and the rise of Chinese CDS. What the fuck is that all about?

What to do, what to do?

 

Sound familiar?

Now let’s examine the internals of this bad market.

37.8% of stocks are down 20% for the year (1,629 of 4,306). That sounds really awful. But let’s dig deeper than a headline number.

18.1% of stocks with market caps over $10 bill are down 20%, YTD (107 of 590).

19.4% of stocks with market caps over $5 bill are down 20%, YTD (180 of 925).

51.3% of stocks with market caps under $1 bill are down 20%, YTD (1,133 of 2,206).

56.5% of stocks with market caps under $500 mill are down 20%, YTD (944 of 1,670).

60.5% of stocks with market caps under $250 mill are down 20%, YTD (714 of 1,180).

67.2% of stocks with market caps under $100 mill are down 20%, YTD (466 of 693).

72.4% of stocks with market caps under $50 mill are down 20%, YTD (302 of 417).

Do you see what’s going on here? Buying smaller cap stocks is inherently riskier than large capped. But these numbers are staggering. The vast majority of large cap stocks are holding up well, especially in comparison to small caps. For the most part, small caps do not have large institutional holders, lose a bunch of money, and have a weak, retail, oriented shareholder bases. The pain is always felt the worst here.

Were these small caps bought on Friday? Let’s have a look.

Friday’s rally, average and median returns

(sorted by market cap)

Over $10 bill: +1.54%/ +1.18%

Over $5 bill: +1.56%/ +1.18%

Under $1 bill: +1.83%/ +1.04%

Under $500 mill: +1.90%/ +1.03%

Under $250 mill: +1.74%/ +0.80%

Under $100 mill: +1.55%/ 0.67%

Under $50 mill: +1.24%/ 0.00%

Data provided by Exodus

Notice how the lower the market cap went, the lesser the gains? The higher average returns with market caps under $1 bill were coupled with a lesser number for the median, indicative of poor breadth and a few outliers that made up for the higher average returns. Looking at these numbers, I think it’s fair to say the best way to position for a bounce is with a portfolio of stocks between market caps of $5-10 bill, with maybe one or two small cap stocks for dicerolls.

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