The S&P 500 is a market cap-weighted index meaning the largest companies by market cap have the greatest impact on its direction. A handful of companies comprise a third of the index today. I explained this in-depth in my series, The Truth Behind the S&P 500. Caitlin McCabe explains in The Wall Street Journal that despite a rally in the overall index driven by a few star names, investors are worried about what lies beneath. She writes:
Major indexes have overcome a series of challenges to power higher this year. But some investors are worried that this performance rests on just a few heavyweight stocks.
The S&P 500 has climbed 11% this year and is poised to enter a new bull market after rising almost 20% from an October trough. Most major indexes in Europe are up more than 10% in 2023, with France’s CAC 40 among those that are hovering near all-time highs.
The performance has surprised asset managers who began the year on the sidelines amid concerns about the trajectory of interest rates and the global economy. Indexes have shrugged off a banking crisis and debt-ceiling standoff in the U.S., and worries of recession in Europe.
But for some investors and analysts, things don’t look so cheery below the surface. Market breadth, which reflects how many stocks participate in a rally, has narrowed, signaling possible trouble ahead.
“If you look at the S&P 500 index level, you might be fooled into thinking that actually the market is doing really well, that activity is strong and that profit growth is in full recovery mode,” said Seema Shah, chief global strategist at Principal Asset Management. “But that would be quite an incorrect reflection of what’s going on under the surface.”
The past few years have been periodically marked by U.S. technology-stock dominance. But that grip has tightened recently. Eight of the largest tech and growth companies in the U.S.—Alphabet, Amazon, Apple, Meta, Microsoft, Netflix, Tesla and Nvidia—now account for 30% of the S&P 500’s market capitalization. That is up from about 22% at the start of the year.
One sign of narrowing breadth can be seen in how the S&P 500 has fared this year compared with its equally weighted counterpart, which gives equal sway to every company in the index. Compared with the traditional index’s 11% gain, the equally weighted version has added 1.1%. That is the largest-ever outperformance by the S&P 500 on a year-to-date basis, according to a Dow Jones Market Data analysis through June 5, based on data starting in 1990.
Other indicators of market breadth have also flashed warning signs. The share of S&P 500 stocks closing above 200-day moving averages fell as low as 38% last week.
A market is generally considered healthier when more stocks are rising together, and history shows that broader rallies are typically more sustainable.
Action Line: Call it what you want, but the storm clouds have formed, and it’s hard to believe this will last forever. Stick with me.
Originally posted on Your Survival Guy.
