Rotation, Resilience and the Risk of a Deeper Correction

Dow Jones — last week:

The Dow Jones Industrial Average finished a volatile week higher, gaining approximately 0.4% for the week, despite a sharp reversal on Friday. The index closed at 52,215.16, down 652.82 points, or 1.23%, on the final trading session. (AP News)

Market takeaway

The Dow's positive weekly performance contrasted with losses in the S&P 500 and Nasdaq, suggesting that money was rotating away from some technology and semiconductor names rather than exiting equities across the board. Small-cap stocks also outperformed, with the Russell 2000 gaining approximately 2% for the week. (Finansignal)

My interpretation: The Dow's resilience is encouraging, but Friday's selloff is a reminder that the market remains vulnerable to rising energy costs, inflation pressures and uncertainty over whether heavy AI spending will generate sufficient returns. I would remain constructive but cautious, watching whether strength broadens across sectors or becomes increasingly selective.

S&P 500 — last week:

The S&P 500 finished the week lower, closing at 7,623.68, down approximately 0.5%. The index experienced a volatile stretch as technology shares weakened, energy prices climbed and investors reassessed the outlook for artificial intelligence spending. (AP News)

Market takeaway

The S&P's weekly decline reflects a market struggling to reconcile strong corporate earnings expectations with growing concerns about valuations, inflation and the sustainability of AI-related investment. Earnings remain an important source of support, but higher energy prices and rising bond yields could place additional pressure on stock valuations. (Fidelity)

My interpretation: The S&P remains in a longer-term uptrend, but the recent price action warrants caution. I would be watching market breadth closely to determine whether weakness is confined to technology or beginning to spread across the broader market. Next week's major corporate earnings reports and Federal Reserve meeting could prove pivotal. A market supported by only a handful of leading stocks is more vulnerable to a correction if those leaders begin to falter. (Fidelity)

Nasdaq Weekly — last week:

The Nasdaq Composite finished the week down 0.71%, closing at 25,955.34, as renewed concerns about the cost and profitability of artificial intelligence investments pressured technology shares. Thursday's sharp selloff erased much of the gains made earlier in the week. (Portfolio Terminal +1)

The key issue remains whether the anticipated returns from AI spending will justify the enormous capital commitments being made by major technology companies. Investors are becoming more sensitive to financing costs, valuations and the timing of future earnings.

My interpretation: The Nasdaq is showing greater vulnerability than the broader market, reinforcing the need for caution. While the longer-term technology and AI story remains compelling, Thursday's sharp decline demonstrates how quickly sentiment can change when expectations become excessive. I would be watching the semiconductor sector, particularly the SMH, for signs of stabilization, while monitoring whether weakness spreads into other technology groups.

The coming week will be important, with major corporate earnings and the Federal Reserve's policy meeting likely to influence market direction. Until technology shares regain their footing and market participation improves, I would avoid interpreting every rebound as evidence that the correction risk has passed. (Fidelity +1)

SMH — last week:

The semiconductor sector endured a difficult week, with the SMH falling 4.56% for the week, despite rebounding 0.7% on Friday to close at $527.20. The late-week recovery was not enough to offset Thursday's heavy selling pressure. (GuruFocus)

Market takeaway

SMH remains an important barometer for the broader technology trade. When semiconductors weaken sharply, it can signal that investors are reassessing the sustainability of the AI-driven rally. The sector's longer-term growth story remains intact, but elevated expectations leave it vulnerable to disappointing earnings, margin pressure or a slowdown in capital spending.

My interpretation: I would approach the semiconductor sector with increased caution. The key question is whether this week's decline represents a healthy correction within a longer-term uptrend or the beginning of a more meaningful repricing of AI-related stocks. I would watch SMH's ability to stabilize, along with the performance of its largest holdings and overall Nasdaq breadth, before treating a rebound as confirmation of renewed strength.

The distinction is important: AI demand can remain strong even while semiconductor stocks correct if valuations have moved too far ahead of earnings. (GuruFocus)

Russell 2000 — last week:

The Russell 2000 delivered one of the week's strongest performances, gaining approximately 2.0% to finish at 2,775.90, even as the S&P 500 and Nasdaq ended the week lower. Small-cap stocks demonstrated relative strength despite Friday's pullback. (Portfolio Terminal)

Market takeaway

The Russell's outperformance is encouraging because small-cap companies tend to be more sensitive to domestic economic conditions, financing costs and credit availability. Their relative strength suggests that investors have not abandoned the broader market, even as technology shares came under pressure.

My interpretation: The Russell 2000 is an important indicator to watch in assessing market breadth. Its 2% weekly advance, while the Nasdaq lost 0.7% and the S&P 500 declined 0.5%, points to a rotation toward smaller companies. (Opening Bell Daily)

However, I would not treat one strong week as confirmation of a sustained breakout. Higher Treasury yields and rising energy prices could eventually weigh on smaller companies, particularly those with greater borrowing needs. The next question is whether the Russell can maintain its relative strength and continue participating if the major indexes attempt another advance.

Bottom line: The Russell provided a positive sign for market breadth this week, but continued strength—not a single week's outperformance—will determine whether this rotation is sustainable.

HYG — last week:

HYG finished the week at $77.05, up approximately 0.25% from the previous Friday's close of $76.86. Despite volatility in equities, high-yield corporate bonds showed modest price resilience. (Schwab Wall St)

Market takeaway

HYG is an important credit-market indicator because it tracks below-investment-grade corporate bonds. Its performance can help reveal whether investors are becoming more concerned about corporate credit risk and the possibility of economic deterioration.

My interpretation: HYG's modest weekly gain is a constructive sign. While the Nasdaq and semiconductor stocks came under pressure, high-yield credit did not experience a comparable selloff. That suggests the equity weakness has not yet translated into an obvious, broad-based deterioration in credit sentiment.

However, I would not interpret this as an all-clear signal. HYG's price has declined over the past month, and its 30-day SEC yield was 7.36% as of October 19, reflecting the higher income available from lower-rated corporate debt. HYG +1

The key issue for next week is divergence. If the Nasdaq continues to weaken while HYG remains stable, that would suggest the pressure is concentrated in equity valuations, particularly technology. If HYG begins to break down alongside stocks, I would become more concerned about a broader risk-off move and potential widening of credit spreads.

Financial stocks: what the numbers tell us

Financials were a relative bright spot over the full week. The Financial Select Sector SPDR ETF (XLF) gained 0.68%, although it fell 1.32% on Friday as selling returned to the broader market. (Dependability Holdings LLC +1)

Bottom line: Financials' weekly gain, alongside the Russell 2000's 2% advance, provides some evidence of market participation beyond technology. However, Friday's decline in XLF shows that this strength is not yet decisive. With Treasury yields near 5% and oil prices rising, I would watch bank stocks and credit conditions closely. If financials continue to hold up while the Nasdaq struggles, that would support the case for sector rotation rather than a broad market breakdown. If financials begin to weaken alongside HYG, the risk of a wider correction increases.

You’ve lost your taste for risk with all the talk of CoreWeave’sdebt and an AI bubble about to pop. You crave safe, lower-risk stocks that would—in theory—hold up well in a market selloff.

Dissuade yourself of that notion. It could be a big mistake.

Some low-risk names, aka low-beta—actually perform worse on big down days for the market than investors would expect, writes Trivariate Research’s Adam Parker.

Beta is a measure of how much a stock moves compared with the S&P 500. Stocks with a beta below 1 fall less than the broader market when the index is declining and ones with a beta above 1 fall more. On up days, low-beta stocks gain less and high-beta stocks gain more.

Parker is “worried that many investors own low beta names that are not holding up when the market sells off.”

Plus, most institutional investors like pension funds or mutual funds own less stock in the Magnificent Seven and Broadcom—a group Parker calls the “Great 8”—than they typically should.

If money starts flowing back into tech companies, those investors will miss out on the gains unless they quickly buy more of the Great 8. Missing out would make their fund performance look bad compared with the market.

“A concentrated market with more volatility is likely,” he wrote, noting that the so-called gigacap Great 8 stocks “have a meaningful chance of outperforming.”

That means investors need to be wary of the stocks that look relatively safe but actually have big drops on particularly rough days for the broader market.

That list includes defense giant RTX, Charles Schwab, railroad Union Pacific and its proposed merger partner Norfolk Southern, life sciences conglomerate Danaher, Starbucks, uniform company Cintas, and Intuit.

All eight stocks have betas well below 1. But their betas spiked on big down days, according to Parker and his researchers at Trivariate.

Starbucks, for example, has an average beta of 0.36 this year through the end of September. But its beta surged to 1.6 on days when the S&P 500 fell more than 0.75%.

In other words, Starbucks shares did 60% worse than the index on tough days for the broader market. Schwab was another stock that fared particularly worse than the S&P 500 in difficult stretches for the market. Its beta rose from 0.46 to 1.31.

“We want to be cautious of stocks that appear to be low beta, but aren’t
so on down days,” Parker wrote.

Keep that in mind the next time the broader market takes a nasty tumble. The stocks that look safe on normal days may be anything but stable if the S&P 500 is getting hit in a broad-based selloff.

Parker also identified several stocks that have held up quite well during all the AI turmoil.

Telecoms Verizon Communications and AT&T, known for their big dividends, metal packaging manufacturer Crown Holdings, insurance broker Aon, and Apple were all up at least nine times out of 10 on days where chip stocks fell more than 1% through mid-October.

So it turns out that there are places to hide when the market is choppy. It just may not be low-beta stocks.

This week is the busiest on the Q-3 earnings calendar. GOOG, MSFT, AMZN and INTC lead the pack.

Wednesday: FOMC announces its monetary policy

Thursday: PCE

This past week reinforced my view that we should remain constructive on the longer-term market outlook, but increasingly cautious in the near term. The Dow and S&P 500 finished lower on Friday, while the Nasdaq and, more notably, the semiconductor sector came under pressure. The sharp decline in SMH raises an important question: are we witnessing a normal correction within a longer-term uptrend, or are investors beginning to reassess the valuations and future returns of the AI trade?

There were, however, some encouraging signs. The Russell 2000 outperformed, and financial stocks posted a weekly gain, suggesting that money is rotating beyond the technology leaders. HYG also held relatively firm. This divergence between high-yield credit and the Nasdaq is worth watching closely. For now, credit markets are not confirming the same degree of weakness seen in technology stocks, but that could change quickly if selling pressure broadens.

Market breadth remains the critical factor. A healthy advance requires participation across sectors, not just a handful of heavily weighted technology and semiconductor stocks. The Russell's strength and financials' relative resilience are positive developments, but they need to persist. At the same time, I want to see SMH stabilize and the Nasdaq regain its footing before concluding that the recent selling has run its course.

My concern is that investors may be underestimating the potential impact of rising oil prices, elevated Treasury yields and renewed inflation pressures. These factors could limit the Federal Reserve's flexibility and place additional pressure on valuations. Friday's weakness also reminds us that a rebound, when it occurs, should not automatically be interpreted as a durable recovery. We need confirmation through price action, improving breadth and sustained participation.

My strategy remains disciplined rather than bearish. I am not abandoning the longer-term bullish case, but I am unwilling to dismiss the warning signs or chase rallies without confirmation. If HYG begins to weaken alongside the Nasdaq, SMH, and financials, I would become more concerned that this is evolving into a broader risk-off environment. Conversely, stabilization in technology, continued strength in small caps and financials, and improving breadth would strengthen the case that capital is rotating rather than leaving the market altogether.

The bottom line is that I believe opportunities will continue to emerge, but the risk-reward equation demands greater selectivity. I would rather wait for the market to demonstrate genuine underlying strength than assume every pullback is a buying opportunity. The longer-term trend may remain intact, but until breadth improves and the major indexes regain their footing, caution—not complacency—should guide our decisions.

– Richie

This content (“Content”) is produced by Richard Naso. The Content represents only the views and opinions of Mr. Naso who is compensated by TradeZero for producing it. Mr. Naso’s trading experiences and accomplishments are unique, and your trading results may vary substantially from his. TradeZero does not endorse the Content and makes no representations or warranties with respect to the accuracy of the Content or information available through any referenced or linked third party sites. The Content has been made available for informational and educational purposes only and should not be considered trading or investment advice or a recommendation as to any security. Trading securities can involve high risk and potential loss of funds. Furthermore, trading on margin is for experienced investors and traders only as the amount you may lose can be greater than your initial investment. Likewise, short selling as a securities trading strategy is extremely risky and can lead to potentially unlimited losses. Options trading is not suitable for all investors as it can involve risk that may expose investors to significant losses. Please read the Characteristics and Risk of Standardized Options, also known as the options disclosure document (ODD) before deciding to engage in options trading.

TradeZero provides self-directed brokerage accounts to customers through its operating affiliates: TradeZero America, Inc., a United States broker dealer, registered with the SEC and member of the Financial Industry Regulatory Authority (FINRA) and the Securities Investor Protection Corporation (SIPC); TradeZero, Inc., a Bahamian broker dealer, registered with the Securities Commission of the Bahamas; TradeZero Canada Securities ULC, a Canadian broker dealer, member firm of Canadian Investment Regulatory Organization (CIRO) and member of the Canadian Investor Protection Fund (CIPF); and TradeZero Europe B.V., a Dutch broker dealer, authorized and regulated by the Netherlands Authority for the Financial Markets (AFM) and subject to the regulatory framework of the European Securities and Markets Authority (ESMA) under MiFID II (collectively, the “TradeZero Broker Dealers”).