Generally speaking, although the conversations and debates persist, the U.S. Stock Market seems to have calmed down to some degree over the past few months.
Most market “experts” believe that the financial stress/environment which led to the unwinding of Silicon Valley Bank, First Republic and Signature Bank is well contained and being handled expertly by the market, its participants and its regulators. Additionally, S&P 500 earnings expectations are still relatively optimistic with a current P/E and Forward P/E of 18.50 and 18.75, respectively. Geopolitical risks seem to go totally unaccounted for, inflation (YoY CPI) is currently under control at 5% (side eye) and the unemployment rate in the U.S. is only 3.50%. Also often highlighted is the fact that the S&P 500 Index is about 20% off the 2022 low. What could be wrong?
Well let's focus on this last point. The US Stock Market is rallying and holding well above the 2022 lows. This could only mean that we have seen the worst of this Bear Market and better times are ahead. Well, maybe not.
Let’s look at what’s under the hood. What is really driving price? Is this a market where the average stock is recovering and performing or is this a shallow price recovery as far as market breadth. Are we seeing higher overall prices being produced from the success of only a few names, while most stocks continue to struggle?
To start, let’s look at three broad indexes which generally encompass Technology (Nasdaq), Large-Cap U.S. Equities (S&P 500) and Small Cap Equities (Russell 2000). What we see is that on a year to date basis, technology has massively outperformed both large and small cap equities in general. The chart below shows the Nasdaq (QQQ.US) up 22% with the S&P 500 (SPY.US) up only 9% and the Russell 2000 (IWM.US) up only 1%. This is not typical for a market that is truly recovering from a Bear market low. We should want to see money flowing into the Small Cap names as a sign that market participants believe there will be an economic recovery, lower rates and higher growth in the future. This is not at all what we are seeing.
To go a step further, what is driving our broader market (S&P 500) even 9% higher on a year-to-date basis? Is it all technology names or is it a concentrated few that, because of index construction and weightings, have been able to disguise a weak market as a strong, emerging bull? An easy way to assess how healthy breadth is for the S&P 500 universe is to compare the performance of the cap weighted index (SPY.US) versus the equal weight index (RSP.US). By taking this angle we can easily see to what degree all stocks are improving versus just the largest of the large caps. The chart below shows a significant underperformance by the equal weight basket. The SPY.US is up 10% year to date while the RSP.US is up only 3%. To go a step further, the top three names by cap weight in the SPY.US are Apple, Microsoft and Amazon. These three stocks alone account for almost 20% of the S&P 500 and are all individually up 30% year-to-date. Think about that, three names out of 500 account for 20% of the index move and these same three names are outperforming the overall market by approximately 10x.
Be careful when reading the headlines or defining true market health as measured by potentially skewed data and indexes. For the U.S. equities markets to truly enter into the next bull market we will need more than the chosen few to rally and show demand outweighs supply.
