Forget the Dow: This Stock Market Index Teases the Economy’s Grisly Future

March 31, 2020 8:53 PM UTC
Forget the Dow. If you're curious where the economy's headed, Wall Street's most stubborn bear says to watch a different stock market index that's flashing a big warning signal.
  • The Dow and S&P 500 have rocketed off their recent lows.
  • But one economist says that mega-cap stocks are masking pain in the broader market – especially in the small-cap segment.
  • That’s a bad sign for the economy, and it might be even worse for the stock market.

As the U.S. stock market closes the book on one of its worst quarters in history, the mood on some corners of Wall Street is surprisingly upbeat. The Dow Jones has rocketed almost 20% off its lows, while the S&P 500 has bounced more than 15%.

A growing chorus of analysts proclaim that the stock market crash is over, and even cautious strategists say the “sell everything” moment has passed. But Wall Street’s most stubborn bear refuses to concede the point.

David Rosenberg predicts the coming economic recession could be twice as ugly as 2008, and he says the evidence is staring investors straight in the face. They’re just too dazzled by other corners of the stock market to see it.

This Stock Market Index Sends an Ominous Warning About the Economy

The Dow (black) and S&P 500 (red) are surging back to life, but David Rosenberg says this recovery is just white noise distracting investors from the movements that really matter. | Source: Yahoo Finance

The Rosenberg Research chief economist says that there is a stock market index that “tells you what is going to happen with the economy.” But it’s not the Dow, and it’s not even the S&P 500.

It’s the large-cap index’s “little brother” – the S&P 600. This index tracks the small-cap segment of the stock market, and if you think the Dow’s chart looks horrendous, you’ll find this one absolutely nauseating.

Source: Twitter

Rosenberg says that it’s a bad sign that historic levels of government stimulus have failed to spark a convincing recovery in small-cap stocks. He warns that this forebodes an ugly future for the economy: “Deep recession, minimal recovery.”

The S&P 600 doesn’t include the mega-caps and even with all the stimulus in the world, there has been virtually no bounce at all. This is the index that tells you what is going to happen with the economy. Deep recession, minimal recovery.

The even more sobering fact is that it’s not just small-caps that are struggling.

Mega-Caps Pump Dow and S&P 500 While Many Large-Caps Struggle

The S&P 500 is weighted by market cap, which means mammoth companies like Apple hold extraordinary sway over the large-cap index. But the Equal-Weighted S&P 500 Index – which balances the member stocks equally – is still languishing nearly 30% off its highs.

As Rosenberg comments:

Some of my buddies in the strategy community are saying we’re still in a secular bull market. Meanwhile, even with this oversold bounce off the lows, the equal-weighed S&P 500 index is still down 28% from the peak! It’s a bull market only if you flip the chart upside down!

So what explains the wide disparity between the performance of the S&P 600 and blue-chip indices like the Dow and S&P 500?

A handful of the stock market’s most valuable stocks. An exclusive group known as the “mega-caps.”

Take Microsoft and Amazon – the second and third largest publicly-traded U.S. companies – which both closed the first quarter in the green despite the wider stock market plunge. Apple is down 13% in 2020, though the country’s most valuable corporation is still up 35% year-on-year.

It’s a similar story throughout the mega-cap segment. The Vanguard Mega Cap Index Fund ETF, which tracks the performance of the CRSP US Mega Cap Index, is down just 6% year-on-year. The S&P 600 has bled 27% lower.

Mega-cap stocks (black) have wildly outperformed the S&P 600 (red) over the past year. | Source: Yahoo Finance

Are ‘Mom & Pop’ to Blame for This Stock Market Disparity?

One theory for the stark divergence between small-cap and mega-cap stocks is the classic story of investors fleeing to safety ahead of economic pain. They don’t want to exit the market altogether, so they target corporations that should be able to survive a recession comfortably and then bounce back quickly in its aftermath.

That’s not exactly a bullish signal for the economy, but another plausible theory is exponentially more bearish for the stock market. Retail traders are buying familiar names because they believe the stock market is “cheap.”

As we reported last week, Google searches for “how to buy stocks” smashed records as the Dow began its precipitous crash in early March, and they remain at wildly-elevated levels compared to the previous bull market.

When someone who searches “how to buy stocks” makes a trade, you probably want your money to be on the other side. | Source: Google Trends

That’s a contrarian signal because “Mom and Pop” tend to buy when the market is at a peak and then finally capitulate just as the sell-off is reaching a bottom.

At best, these low-information speculators are buying index funds. More frequently, they’re buying Apple stock because they like iPhones and Tesla stock because electric cars are cool (and Elon Musk posts funny memes). They’re probably not buying small-cap stocks unless the companies grow weed or are working on a coronavirus vaccine.

To put it more bluntly: When someone who searches “how to buy stocks” makes a trade, you probably want your money to be on the other side.

Disclaimer: The opinions in this article do not represent investment or trading advice from CCN.com

Josiah Wilmoth edited this article for CCN.com. If you see a breach of our Code of Ethics or find a factual, spelling, or grammar error, please contact us.

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