Growth Stocks Being Dumped a Big Warning Sign?

Growth Stocks Being DumpedIf you have been holding small-cap growth stocks over the past several weeks, you have probably noticed that many of these higher beta stocks are being dumped indiscriminately. If you don’t actively monitor your portfolio, you’d better begin, as there could be more selling.

Smaller companies, or those many refer to as companies with a market capitalization below $1.5 billon, tend to trade in line with the economy and growth. The fact that this group has been selling off suggests there may be concerns with the prospects of stronger economic growth.

While the first reading of the second-quarter gross domestic product (GDP) was pretty good at an annualized 2.3%, the fact that corporate revenues are declining is not a good sign and really doesn’t support a higher GDP. The fact is less corporate revenues could imply less spending by consumers and companies, which is a negative for the economy.

Growth Stocks: The Ups and Downs

Growth stocks are fantastic when the economy is growing. These smaller companies tend to be able to adapt quicker to economic changes and hence react in a more timely way when an economy grows. On the other hand, if the economy shows signs of slowing, the impact on smaller companies can be much more dramatic, as these companies tend to have less cash and credit resources to withstand a slowdown.

The current weakness in small-cap stocks may foreshadow a pending slowdown, with investors selling ahead of the potential slowing. Of course, this may not be the case and could simply be a case of investors deciding to lighten their allocation to small-cap growth stocks.

Whatever the reason, be careful; small-caps are currently under selling pressure.

What the Russell 2000 Chart Says

The Russell 2000 has been turning lower with the index declining below its 200-day moving average (MA) on Thursday and joining the 50-day moving average, previously broken.

While things can improve, you also have to be cognizant of the 50-day MA breaks below the 200-day MA and form a bearish death cross on the chart. We are not there yet, but the index has corrected 6.4% from its record high of 1,296 on June 23.

Russell 2000 Small Cap Index Chart

Chart courtesy of www.StockCharts.com

With the current weakness, the Russell 2000 has seen its gain cut to a mere 0.69% this year as of last Thursday. This is better than the 2.3% decline by the blue chip Dow this year but well below the 6.82% upside move by the NASDAQ.

The Russell 2000 has made five new lows over the past month while recording four new highs. A continuance of this pattern could see the index move lower, below 1,200, and at a 50% retracement from its 52-week high at 1,168.

What Investors Can Do

If you are holding small-cap stocks from years ago, you are probably up quite a lot. In these cases, you could lighten your exposure to small-cap stocks and avoid potentially more downside moves. An alternative would be to hedge your risk via put options on the Russell 2000 or another small-cap ETF.