I’m going to recount one of legendary Merrill Lynch strategist Bob Farrell’s 10 Market Rules to Remember for the second time this month because it’s too topical to avoid. Mr. Farrell’s rule number seven is “Markets are strongest when they are broad, and weakest when they narrow to a handful of blue-chip names.” From this perspective, U.S. markets are currently extremely fragile.
Morgan Stanley Wealth Management chief investment officer Lisa Shalett reported this week that by one measure, using the S&P 500 Equal Weight Index, the current market is more narrow than at any time since the year 2000 when the internet bubble was imploding.
In the conventional market cap-weighted S&P 500, the performance of the largest stocks affects index returns by a lot more than smaller companies. A one per cent move in Apple Inc., for instance, will affect benchmark returns 446 times more strongly than a one per cent move in American Airlines Group Inc.
In the equal weighted index, returns for all stocks affect the index equally. Ms. Shalett divides the two-year performance of the market cap-weighted index by the same period returns for the equal weighted benchmark. The result uncovers the extent to which large cap stocks are dominating index returns or, in other words, the narrowness of the market.
The strategist’s data show that the current market leaders – Nvidia Corp., Microsoft Corp., Apple Inc., Alphabet Inc., Amazon.com Inc. and Meta Platforms Inc. – dominate returns to a similar scale to the year 2000′s four horsemen of Cisco, Dell, Intel and Microsoft when the tech bubble ended. (Tesla, the remaining so-called Magnificent Seven stock, has seen significant declines this year.)
Morgan Stanley notes that so far in the second quarter (using weekly data), Nvidia is up more than 40 per cent, the Magnificent Seven is up more than 15 per cent, the index is higher by 3 per cent while the other non-Magnificent 493 companies are down 2 per cent.
There are further signs of overheating for market leaders. Nvidia has added US$1-trillion in market capitalization since the end of February and this is more than the entire market cap of Berkshire Hathaway.
I noted briefly in Monday’s newsletter that BofA Securities’ U.S. equity and quant strategist Savita Subramanian does not believe that market breadth has been a consistent indicator of market peaks. Still, a market rally driven almost entirely by stocks we can count on one hand is intuitively more precarious and investors will likely breathe a sigh of relief if leadership broadens.
-- Scott Barlow, Globe and Mail market strategist
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