Small Cap Stocks are Hit the Hardest as the Market Correction Unfolds; Avoid the Falling Knives; Large Cap Stocks and Biotechs Can Lead the Market when the Next Rally Arrives

Today was a tough day for stock investors. A toxic brew of bad news caused another round of market sell off, but now the volume is increasing, which is definitely not a good sign. The Russell 2000 index, representing small cap stocks, was hit the hardest out of the major U.S. stock indexes. Small cap stocks typically outperform during the expansionary phase of the economic cycle. Consequently, the underperformance of the small cap index versus the large cap S&P 500 index is a worrisome sign.

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In spite of the best efforts by the ECB, increased concern about economic contraction in Europe has caused Eurozone markets to enter a downtrend in July. As the Wall Street adage says, “do not try to catch a falling knife”, we believe that investors are best served to continue to avoid Eurozone investments until the proverbial knife hits the floor. Currently, no floor is in sight.

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Crude oil and other commodities tend to be priced in dollar terms, so as the dollar rallied against all major currencies starting in July, stocks in the energy sector to sell off. The sell off is also exacerbated by concerns about a possible world-wide economic weakness. We will continue to watch the relative strength of the energy sector compared to the S&P 500 index to look for a turn-around that may be similar to what we have seen in February.

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On the bright side, the bull market is still intact for large cap stocks as investors seek out the safety of blue chip companies. As we reported earlier (see article), a rotation of capital is under way into large cap stocks.

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Biotechnology is another area of the stock market that is still holding up. While investing in the biotech sector is appropriate only for aggressive investors, tracking this sector can give us clues about the ability of the stock market to rebound from the correction.

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View investment strategies at FidelitySignal.com

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The Dow Jones Industrial Average Index cannot Hold the 17,000 Level; Biotech Sector Shows Signs of a Possible Correction; Real Estate Stocks may be Ready for a New Rally

Ahead of the July 4th holiday, the Dow Jones Industrial Average briefly reached the all-time high 17,000 level, but was not able to hold it this week. The chart below shows that the Dow is still in a bullish uptrend, but what makes us concerned is the more severe sell-off in market leading sectors, such as biotechnology.

We are also approaching the seasonally weak fall period. Since many of the infamous stock market crashes occurred between September and November, we caution our readers to be increasingly careful with committing new funds to “risk on” investments.

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The biotech sector has been one of the market leaders in the last 18 months. The chart shows that the sector corrected hard from the March highs in April and May, but was able to rally back in June. The large 3.14% drop of the Fidelity Biotechnology Fund (FBIOX), which is the largest biotechnology fund available to investors, is concerning, because it may signal the start of a market correction.

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While aggressive equity sectors got hit hard today, long-term Treasury bond rates trended lower, which helped interest rate sensitive investments to go higher. One of our current favorites in this space is the Fidelity Real Estate Portfolio Fund (FRESX). FRESX was one of the few Fidelity funds that posted a gain today and we would not be surprised to see FRESX to hold its current bullish trend even if stock market conditions weaken.

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Buy and sell signals for Fidelity funds are available at FidelitySignal.com

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The Best Fidelity Funds Right Now May Surprise You

Volatility has increased in the equity markets in the last two weeks, which makes it confusing for investors to see where the market is headed. That is why it may be useful to take a look at the top 10 ranked Fidelity funds (ranking is provided by FidelitySignal):

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To make sense of the current market dynamics, let’s focus on the Fidelity funds with green arrows in the weekly column. These are the investments that both make the top 10 ranking and also have increased their rank compared to a week ago.

On top of the list is the Fidelity Select Natural Gas Fund (FSNGX). The top panel in the chart below shows that FSNGX has a very strong relative strength (ratio of the the fund and the $SPY tracking index) compared to the S&P 500 index:

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Our second example is the Fidelity Select Natural Resources Fund (FNARX). As noted in earlier blog articles, FNARX continues to outperform other equity sectors:

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The third example is the Fidelity Real Estate Income Fund (FRIFX). We highlighted FRIFX as a top income investment choice for 2014 in previous articles and FRIFX continues to show a strong positive trend:

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Now, let’s contrast our top  movers with the currently weakest sector, which is biotechnology (see FBIOX chart below):

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In conclusion, while utilities and other defensive sectors are making gains, as well, the current market environment seems to favor natural resources and real estate investments.

 

Buy and sell signals are available at FidelitySignal.com

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Market Correction: Treasury Bond Fund is Trending Higher; Biotechnology Sector is at Oversold Levels and May See a Bounce Next Week

We noted in in the March 26 blog article that the sector rotation has intensified as we approach the seasonally weak April-May period. In the last two weeks the stock market sell off continued, which negatively impacted most equity mutual funds.

Long-term interest rates have also started to decline, which benefits the Fidelity Spartan Long-Term Treasury Bond Fund (FLBIX). The chart below shows the inverse correlation of FLBIX and interest rates (see $TYX, the 30-year Treasury Bond Yield Index on the top panel).

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The biotechnology sector corrected the hardest in recent weeks. However, technical indicators show now that we have reached an oversold condition and a bounce is likely in the coming week:

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Source: FidelitySignal.com

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Sector Rotation Intensifies as we Approach the Seasonally Weak April-May Period

“Sell in May and go away” is a well know Wall Street adage that warns investors to sell their equity holdings in May to avoid the seasonal decline of the equity markets. Will the adage prove to be true in 2014? After the outstanding returns of the last 18 months, is the U.S. stock market vulnerable to a serious correction?

We think that the risks for equities have increased and investors should be extremely cautious in this market. As we noted in previous blog articles, the sector rotation has started a week ago and a correction is under way in the previous market-leading sectors, such as biotechnology and gold. At the same time, defensive investments, including utilities and treasury bonds are in favor again. Geopolitical risks may be on the rise, as well, especially if the military conflict in the Ukraine escalates in the coming weeks.

Severe corrections are under way in the biotech and gold sectors:

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At the same time, defensive sectors, such as utilities are gaining favor with investors:

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Source: FidelitySignal.com

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Sector Rotation: Biotechnology Takes the Lead Again in 2014

The Fidelity Select Biotechnology Fund (FBIOX) was the best performing Fidelity mutual fund in 2013. The chart shows that the price of FBIOX consolidated in October and December, but started the new year with impressive gains.

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View the top 10 Fidelity funds at FidelitySignal.com

We’d like to point out that after the recent large gains the biotech sector is overbought now and ripe for a pullback. Investing in this sector carries above average risks, but can be highly rewarding for aggressive investors.

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Bullish Trends is Still Intact for the Fidelity Select Biotechnology Fund

The biotech sector was one of the hardest hit in the stock market sell-off today. However, the one-year chart of the Fidelity Select Biotechnology Fund (FBIOX) shows that the bull market is still intact. The chart also shows that corrections are normal, but to confirm the bullish trend, we would like to see FBIOX making a new high again in the next few weeks.

The reason for the importance of the biotechnology trend is that this sector has led the bull market of 2013. FBIOX turned out to be an excellent way to invest in the biotech sector, just as in past bull markets (e.g. 1999 and 2003). And just as in the past, market leading sectors (and the corresponding Fidelity mutual funds) making higher highs and higher lows were required to propel the broad market indexes higher.

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Buy/sell signals for Fidelity funds are available at FidelitySignal.com