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.


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.


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.


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.


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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Large Price Drop of Fidelity Select Sector Funds is due to Capital Gains Distribution

The large price drop of several Fidelity mutual funds may have alarmed investors today. But it turns out that there is no reason to panic. The drop in the net asset value (NAV) of these funds was due to the annual distribution of capital gains, and also to a smaller extent, dividends.

Looking on the bright side, large distributions are reflective of large gains in 2013. Indeed, 2013 has been an exceptionally strong year for equities. Unless we experience an unexpected sell-off in the last 11 days of the year, 2013 will become the best year in equities, since 1999. Of course, this makes many investors fearful of downside volatility in 2014. But for now, lets focus our attention on closing the year, especially if it involves mutual fund investments that have produced excellent gains for investors.

So, lets take a look at examples of Fidelity funds with large price drops that are due to capital gains distributions:






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