Small-Cap Stocks Down: Profit-Taking? Or Something Worse…

It was a bad day for stocks. The Dow Industrials was down 185 points or 1.9%. The S&P 500 (^GSPC) lost 22 points, the Nasdaq (^IXIC) lost 40 points and the Russell 2000 dropped 15 points or 2.65%. On a percentage basis, the Russell was the biggest loser, which is to be expected. Small cap stocks outperform on both the up and the downside.

Retractable Tech (RVP) was the top small cap gainer today, jumping 103%. This move came on no news that I could find, but somebody knows something - volume was huge.

Mining and oil company U.S. Energy Corp (USEG) came in second with a more reasonable 22% move. Rounding out the top 5 were Anadys Pharmaceutical (ANDS) up 19% Digital Angel (DIGA) up 17%, and Alpha Pro Tech (APT) up 13%.

Not a good day for some small cap biotech stocks. Acadia Pharmaceutical (ACAD) was the top loser with a gut-wrenching 65% decline. Builders FirstSource (BLDR) also made the list with a 35% drop. Other notable losers include, Catalyst Pharmaceutical Partners (CPRX) down 21%, Gander Mountain (GMTN) down 18%, and AIG (AIG), yes THAT AIG, down 18%.

Monday’s headlines made it sound like the sky was falling after China’s Shanghai Index sold off 6.7%. There’s no doubt, bulls are a bit nervous and bears are getting a bit bolder. That’s to be expected after a six month rally that’s been remarkable in that there have been no corrections.

That’s also why it’s imperative to keep a cool head these days: there’s a big difference between what the financial media is saying and what investors are doing.

If you didn’t read the news yesterday and simply watched the S&P 500, you’d wonder what the excitement was all about. The S&P dropped right out of the gate, but quickly recovered and finished the day with a -0.8% loss.

Even Chinese stocks listed on U.S. exchanges made a nice recovery from the early weakness.

The reason U.S. stocks are shrugging off seemingly bad news is pretty simple. The government has guaranteed much of the risk for the financial markets. That’s lead to a recovery for the U.S. economy. And it’s widely expected that the U.S. economy is putting up decent growth numbers in the third quarter, which is now two-thirds over.

Oil’s action Monday is also telling. Yes, oil was down. It traded below $70 a barrel yesterday. But it’s hard to call that bearish. After all, oil just hit a new high at $75 a few days ago. A little consolidation, or profit-taking is in order.

Frankly, the relatively small correction for oil prices seems bullish when you consider how important the China growth story is for oil prices. That could change, of course. But right now, there’s’ no reason to panic that the rally is over and the bear market is coming back.

The main concern for the bulls right now should be third quarter earnings. In my opinion, the low rate of revenue growth for corporations is the biggest threat to the Cash for Clunker Stock Rally.

According to Goldman Sachs (GS), 46% of companies soundly beat earnings expectations in the second quarter. But only 23% did so with a healthy boost to revenues.

For the most part, earnings growth was a result of cost-cutting. And without a rise in revenues, there’s no way for earnings to keep growing. Retail stocks will show this most clearly, as they are most dependent on consumer spending.

Before I finish for the day, I want to discuss Chinese stocks a little more. Yesterday, I mentioned that economist Andy Xie is calling the Shanghai Composite a bubble. And that may be.

But ever time I review the Chinese stocks that are in the SmallCapInvestor PRO (and believe me, I review them frequently), I’m encouraged by the low valuation and attractive growth prospects.

The highest forward P/E among them is 14.5. And the PEG ratios average around .5.

Now, it could be that aggressive lending in China is pumping revenues artificially, and that’s showing up in P/E and PEG ratios. But SmallCapInvestor PRO Chinese stocks are well diversified between energy, biotech, commodity and technology. I’m not convinced that all of these stocks are being lifted by the same loose lending practices.

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