IDAT - U.S. Equities Rally: A Bad Breadth Problem

2023-06-24 05:36:00 ET

Summary

• The S&P 500 has been climbing higher in recent weeks, thanks almost entirely to surging mega-cap stocks that are riding the ripple effects of AI hysteria.
• The S&P 500 has been on an impressive run, rising approximately 13% this year. However, the rally hasn’t been broad based.
• Until mid-June, the five best-performing stocks in the S&P 500 had contributed 60% to S&P 500 returns this year (compared to an average positive contribution of 35% over the past decade).
• Additionally, the market-weighted S&P 500 is outperforming the equal-weighted S&P 500 by 11%—the largest year-to-date outperformance since records began in 1990.
• Despite solid equity performance, bad market breadth requires action in portfolios.

The S&P 500 has been climbing higher in recent weeks, thanks almost entirely to surging mega-cap stocks that are riding the ripple effects of AI hysteria. However, with the rally driven by only a few companies across a narrow set of sectors, the broader market has a bad breadth problem. If these select few stocks fail to deliver on heightened earnings expectations, the broad market may be primed for a pullback.

S&P Technology sector price relative to S&P 500 price 1991–present

Source: S&P Dow Jones, Bloomberg, Principal Asset Management. Data as of June 22, 2023.

The S&P 500 has been on an impressive run, rising approximately 13% this year. However, the rally hasn’t been broad based. Instead, it has been driven by the explosive performance of only a handful of mega-cap stocks across the technology, consumer discretionary, and communications sectors—and all by companies firmly associated with artificial intelligence ( AI ) excitement.

The narrowness of this rally is undeniable:

• Until mid-June, the five best-performing stocks in the S&P 500 had contributed 60% to S&P 500 returns this year (compared to an average positive contribution of 35% over the past decade.)
• Additionally, the market-weighted S&P 500 is outperforming the equal-weighted S&P 500 by 11%—the largest year-to-date outperformance since records began in 1990.
• Even more astounding, the outperformance of the S&P 500 Technology sector over the broader index is now higher than during the dot-com era.

Such narrow market concentration is a potential concern for investors, and against a backdrop of further monetary tightening and economic slowdown, a broadening of the rally looks challenging. From here, if the few stocks driving the rally fail to deliver on elevated earnings expectations, the broad market will likely be exposed to a pullback.

Despite solid equity performance, bad market breadth requires action in portfolios. Diversification via non-U.S. equities, which have lower tech concentration and thus are likely less correlated to the AI excitement, is warranted.

Original Post

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

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