Like traditionalist baseball fans complaining their winning team is too dependent on a couple of big, streaky home-run hitters, the Wall Street crowd is griping that the stock market’s recent resilience owes too much to a small group of massive growth stocks obscuring broader weakness. The math checks out, mostly. The Vanguard Mega Cap Growth basket is up 21% so far this year, while the equal-weighted Russell 1000 is barely positive for 2023. After Friday’s 0.8% lift, the S & P 500 is just a sliver below its Feb. 2 year-to-date high. Yet since that date, Microsoft , Apple , Nvidia and Meta Platforms have collectively added some $800 billion in market value, meaning the other 496 stocks together have in aggregate shed a bit more than that. .SPX YTD mountain S & P 500 YTD The same dynamic is happening at the sector level, too. JP Morgan this year is outperforming the equal-weighted S & P 500 financials by 13 percentage points. In energy, Exxon Mobil’s advantage over the egalitarian version of the energy sector is 14%. Nvidia is up 90% in four months, the equal-weighted semiconductor group only 6.5%. This winner-take-most action is a feature of a broader defensive migration underway in the market, favoring companies with unassailable balance sheets and dominant franchises at a time when capital is less plentiful and more expensive, and when there is a bit less easy economic growth to around. A rational turn, then, at least given the current economic preoccupations. But does this shift in market character imply the market is particularly vulnerable, as the “bad breadth” decriers insist? What does the ‘bad breadth’ really mean? There’s a reason that rallies with broad upside participation by the majority of stocks is considered more bullish. In general, they suggest better demand for stocks, healthier risk appetites and an inclusive fundamental-growth backdrop. Just as a more balanced lineup in baseball will tend to be more consistently successful over a long season. Yet prior periods of extreme outperformance by the few very largest stocks over the many smaller ones don’t imply a single clear message about forward returns. Here is the performance of the ETF containing the Russell Top 50 Index (the 50 biggest stocks by market capitalization) relative to the small-cap Russell 2000 , sitting at a historic and precarious-looking extreme. Early February of last year, the prior time this ratio spiked similarly, preceded a nasty down leg near the start of the 2022 bear market. Yet the three earlier peaks noted occurred near the end of severe corrections and gave way to a broad relief rally. The details now don’t exactly line up – back then the large stocks and small ones had both been falling, with the heavyweights simply going down a lot less. Lately it’s been mega-caps up, smalls down. Still, it’s a reminder that the tape can and does ebb and flow between narrow, selective leadership and all-inclusive relief rallies. Renaissance Macro chairman Jeff deGraaf noted on Friday that while the potential breakdown in small-caps and generally weak breadth are not in themselves healthy characteristics, such dynamics can change pretty quickly. He also notes that key international equity indexes have been trending higher. “While breadth is bad, the S & P 500 is actually one of the weakest indices in the G7,” he says. “I’d rather have global strength and bad [domestic] breadth, than strong breadth and global weakness.” Yes, reliance on the anointed Nasdaq giants (along with Chipotle, Starbucks, some casinos, packaged-food makers and homebuilders) could turn tough should they get overstretched and pull back sharply. Market ignoring recession? But this split market is also a decent rejoinder to another popular complaint, that the tape is somehow ignoring the shadow of recession risk because the S & P 500 has been hovering near multi-month highs and fetches 18-times forward earnings forecasts. Most stocks being weaker than the major indexes and non-cyclical growth giants holding up the benchmark means that the rank-and-file names are digesting uncertain fundamental trends, resetting valuations and frustrating their shareholders. By the way, the top-heaviness of the index also extends to valuation: The equal-weighted S & P 500 is nearer to 15-times earnings. The dominance of the mega-cap favorites would probably be a bigger concern if it were leading investors to grow complacent about the market’s prospects, but most of the sentiment gauges as well as the anecdotal chitchat around the recent action suggests strongly this isn’t happening. Most investors are properly focused on the S & P 500’s inability to bust above a longstanding ceiling around 4200 even with the FAANMG stocks ramping; the nagging weakness in bank shares; and the sense that the economy has not fully reckoned with attenuated growth dynamics and a potential credit contraction. If the crowd were blithely strolling down the sunny side of the Street, one might hear more about how the S & P 500 is flat for the past two years, has now gone six-and-a-half months since a fresh bear-market low, while earnings remain far above pre-pandemic levels and the Federal Reserve is winding down its tightening crusade earlier than feared thanks partly to a regional-bank crisis that wasn’t one. It’s mostly a measure of how depressed profit estimates got before reporting season started, yet some 80% of S & P 500 companies are exceeding first-quarter earnings forecasts and the aggregate year-over-year drop in profits is running at 3.7% versus an anticipated 6.7% decline. More notably, and surprising, the full-year 2023 and 2024 consensus forecasts have actually ticked up slightly, according to FactSet. This is not in itself a reliable sign that the low is in for earnings, but it reflects companies’ confidence for now in the second half of the year. It’s worth noting that, in general, individual stocks have not traded particularly well even when companies have exceeded estimates and affirmed full-year guidance. The monster gains in Microsoft and Meta after reporting results are more the exception this quarter. This captures the big-picture debate that will likely not be settled for some months to come: Are the leading indicators of a near-term recession (Treasury yield curve, rise in continuing unemployment claims, various regional-Fed business surveys) trustworthy in this unusual cycle? Or can the persistent consumer income growth, excess-savings cushion, receding inflation and housing-demand recovery allow the economy to stay in a comfortable nominal-GDP-growth range? And if the latter scenario were to seem plausible for a while longer, would the Federal Reserve tighten even more to make it less so?
