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by Scott Wren, Senior Global Market Strategist
Key takeaways
- Ideally, in a bull market, lots of stocks are participating and breadth is strong.
- That has not been the case in the current rally, as the advance in the S&P 500 has been quite narrow and most stocks are lagging.
Market prognosticators often talk about "breadth." Is a move in the market, up or down, supported by a broad swath of stocks or are just a handful (or a couple of handfuls) of individual company stocks pushing the S&P 500 Index (SPX) one way or the other? That is an important question. Participation from a large number of underlying stocks is typically a much more reliable indicator that the trend in place may very well continue, at least in the very near to intermediate term. But over the past three months or so, breadth has been narrow as the SPX has rallied. Only a limited number of mega-capitalization stocks, largely in the Information Technology and Communication Services sectors, have helped push the index up to levels not seen since mid-August of last year.
In the current case, from a trader’s point of view, the lack of broader participation has built some expectations that the market upswing might not last. But those investors betting against stocks due to weak breadth have not had much to smile about in recent months, despite what we see as deteriorating fundamentals.
A quick look at the traditional SPX versus the S&P 500 equal-weighted index over the past few months tells the story. Recall that the SPX that is reported in the financial news each day is a capitalization-weighted index. That means the highest-valued companies (shares outstanding x price = market capitalization) have the most impact on the underlying movement of the index. The equal-weighted S&P 500 is just that: every stock carries the same weighting in the index.
Ideally, in a bull market, or one that is at least going up, the equal-weighted index is keeping pace with or even outperforming the traditional SPX. That means lots of stocks are participating and breadth is strong. That has not been the case in the more recent rally as the equal-weighted S&P 500 is up just 2.4% versus the 10.8% rise in the SPX since March 10 as of the time of this writing. That tells investors that the advance in the SPX has been quite narrow, and most stocks are lagging.
Further confirmation of a narrow market can be seen in the performance of the S&P 100 (OEX) versus the SPX. The OEX is the 100 largest-capitalization stocks within the SPX. Since the above-mentioned March 10 date, the OEX has traded 14.8% higher, leaving the performance of the SPX far in the rearview mirror (14.8% - 10.8% = 4% outperformance).
The lack of breadth in recent months only adds to our caution on the equity market and the reiteration of our recommendation not to chase this rally. We see economic headwinds building and expect a recession to begin at some point in the coming months. With the Federal Reserve likely to keep interest rates higher for longer and credit conditions tightening, a narrow market rally does not give us confidence that recent gains will hold.
