The stock market is not a democracy. But observers nonetheless like to warn in grave tones that a lack of broad participation by the majority of constituents can create a leadership crisis. Yes, investors are back to worrying about the relative narrowness of the latest phase of the indexes’ advance. The S & P 500 is a mere 1.2% from its all-time high, yet only 60% of its member stocks are up for the year and just over 40% last week were above their 50-day moving average. .SPX YTD mountain S & P 500, 1-year We seem to undergo one of these periods of decrying a lack of market breadth every few months in recent years. Last year, the coinage of the Magnificent Seven grew from the way those huge growth leaders dominated market returns in the wake of the SVB Financial failure and credit scare. In an ideal tape, rallies would be widely inclusive, if only because a heavy preponderance of rising stocks implies forceful demand for equity exposure and a sense that fundamental and/or financial conditions are broadly improving. But does the evidence show that a more selective tape, supported by a relative handful of big winners, is inherently a more treacherous one, or a setup for market accidents ahead? Does breadth matter? It’s not fully clear this is the case. Bespoke Investment Group last week looked at the small number of past instances when the S & P 500 was so close to a record yet most stocks were beneath a 50-day average. Gains in the index ensued more than 70% of the time one to six months hence. While subsequent one-year returns were below average, the performance ranged from up 19% to down 13%. In a bull market, breadth divergences more often resolve to the upside, with most stocks recovering to get back in sync with the index, though this is far from a guarantee. Last year, a very similar pattern of waning internal momentum set in around mid-year, before a broader upturn took the S & P to new highs over the summer (culminating in a minor peak at the end of July followed by a correction), as this chart shows. Warren Pies, founder of 3Fourteen Research, analyzed how markets have done following other conditions that surfaced in the past week or so, including the do-called Hindenburg Omen (an extreme buildup of both new 52-week highs and lows), and the nasty downside reversal following Nvidia’s earnings report, when Nvidia (among the top three S & P weights) jumped 9% and yet the index fell 1% on the day. Nothing so clear as an unambiguous playbook emerges, but consistently the incidence of a significant correction in the following few months was greater than usual. Yet Pies chose not to recommend reducing equity exposure in response, noting that “sentiment and positioning do not resemble market tops” and “earnings breadth is expanding and the momentum signals from earlier this year remain intact.” Nvidia’s influence The market’s erratic, arrhythmic action last week to a large degree spoke to two telltale tendencies of the current operating environment: The extraordinary, almost singular behavior of Nvidia and the way the equity market metabolizes Treasury-yield moves these days. Of the $4.2 trillion in market value gained by the S & P 500 year to date, Nvidia (now at a 6.2% weighting) has alone contributed $1.5 trillion, more than a third of the total. The stock routinely trades a dollar volume that is several multiples of the turnover in Microsoft, Apple, Tesla or Amazon. It is routinely the most active call-option contract. The GraniteShares 2X Long NVDA ETF – which delivers twice the daily move in Nvidia shares – has seen assets vault to $2.8 billion from $200 million five months ago. High-velocity, fast-money flows rushing into and out of the third-largest stock by market cap in the world, a stock that is 120% more volatile than the S & P 500 itself, is a formula for some unusual gyrations and asynchronous moves among the indexes and the majority of stocks. The 100-day correlation between the S & P 500 and the Dow Jones Industrial Average has hit its lowest level since the dot-com bust of the early 2000s, according to CNBC’s Data & Analytics group. The Dow, of course, lacks Nvidia. One can decide whether such a concentration of energy and capital in a single name is a good thing, a dangerous thig, or just something that is. For sure, the excitement around Nvidia and a small number of direct AI and industrial infrastructure-buildout beneficiaries reflects a current scarcity of strong fundamental conviction. Rates’ impact Here’s where the Treasury-yield factor enters. As yields rise (on sticky inflation, solid growth and a scrupulously patient and data-reliant Fed), as they did for two weeks starting May 15, the majority of stocks retreat and money migrates to the huge secular-growth names impervious to macro wobbles and the cost of capital. Banks and small-caps retreat, consumer cyclicals are pressured. The way this market plays defense is to inflate the premium on the acknowledged New Economy winners – which also happen to be among the most expensive, fast-growing and crowded plays in the market. The one-day implosions of both Salesforce.com and Dell Technologies after their earnings showed them to be insufficiently levered to the AI-buildout bonanza (in investors reflex response, at least) reinforce this crowd impulse to hide on a slimmer patch of perceived safe secular themes. Citi equity strategist Scott Chronert on Friday suggested this all shows, “Pockets of the market may be reliant on a consistent beat and raise dynamic through the year to justify current prices. At the index level, the YTD back up in rates intensifies this pressure from a cross-asset valuation lens. Important however is that the mild ~2% pullback from MTD highs has come alongside increasing full year ’24 consensus EPS expectations, which now sit in line with our forecast. We view this as healthy price action, squashing out pockets of exuberance where price has gotten ahead of a still strong fundamental trend.” Indeed, 2024 earnings forecasts have been uncommonly resilient in recent months, avoiding the usual downward-revision path, as this chart from UBS illustrates. When yields retreat – as occurred last Thursday and Friday, with the help of a benign PCE inflation reading – breadth has improved, financials, cyclicals and smaller stocks get relief, and anticipation of more widespread earnings recoveries and perhaps a Fed rate cut lift most boats. Tape refresh In the final quarter-hour of trading on Friday, as if the machines had heard quite enough about worrisome poor breadth, an indiscriminate bid carried nearly all stocks vertically higher to allow the S & P 500 to gain 0.8% — with 80% of all members higher — and narrow the weekly index loss to a mere half a percent. For sure, this was mechanical maneuvering related to the cleanup of month-end reallocations and a heavy-volume quarterly rebalancing of MSCI indexes, most of which is transacted at the close. None of this means the action was illegitimate or overdone, simply that it will need to be tested by human decision makers as June gets underway. I’d boil all this down to a fully valued market that, after an historic seven-month sprint, has churned for two months not far from record highs, the majority of stocks retreating appreciably in a stealth reset. Earnings and the still-expanding economy are key supports. Credit indicators are mostly flashing green. Traditional defensive sectors such as consumer staples and pharmaceuticals have shown no life, a decent macro message. The S & P 500 at the highs hit 21-times forward earnings, and we’ve spent very little time above that outside the pandemic melt-up and the tech boom/bust a quarter-century ago. Investor sentiment and positioning might not be at scary extremes, but nor did they get anywhere near washed out in the April pullback, leaving them rather full. And the acceptable data path for the bulls isn’t all that wide, requiring evident further progress on disinflation while any economy deceleration doesn’t tip toward stall speed. Given this, it wouldn’t be surprising if it took some combination of time, softer share prices and rising profit outlooks (Are we trading on 2025 estimates starting at midyear, already?) to refresh the tape.
S&P 500 enters June near a record but with growing concerns about the market’s narrow leadership
Jun 1, 2024
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