Weekly Buzz: ⚖️ The Magnificent Few: What market breadth tells us

12 July 2024

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5 minute read

A booming stock index looks great at a distance. But get up close and you’ll see it’s usually a mix of both thriving and struggling businesses. That closer look is what you get with market breadth, a measure of how many stocks are advancing versus declining. And right now, that gauge is nearing record lows.

Giants and underdogs

Data from Morgan Stanley showed that only 35% of the 500 largest US stocks have outperformed the S&P 500 index over the past 12 months. This indicates that a minority of stocks are driving the majority of its momentum.

This disparity becomes clearer when we look at market valuations. The S&P 500 is currently trading at about 21 times forward earnings, but if we exclude the top 10 stocks, this figure drops to a more modest 16.5 times. Recent market gains have been disproportionately driven by a handful of heavyweight hitters—AI-powered giants like Nvidia and Microsoft.

A narrow market breadth reveals a lot about the economic backdrop: a combination of higher interest rates, milder growth, and sticky inflation has made it tough for most businesses. Smaller, more vulnerable firms have been hit hard by rising borrowing costs and slower sales.

As an investor, what does this mean for me?

Narrow market breadth can be risky. A dip in any major stock could have an outsized impact: a concentration risk (our Simply Finance section below explains). Diversification—that time-tested strategy of spreading your investments across different assets, sectors, and regions—can help mitigate that risk.

This concentration risk is also why we added an equal-weight S&P 500 ETF with our previous reoptimisation. Unlike a market-cap weighted approach, where the largest companies have the biggest impact, an equal-weight ETF gives equal importance to each firm in the index, providing a more diversified exposure to the US.

📰 In Other News: The tech sector continues to power global stocks

The S&P 500 just celebrated its 35th record close this year, largely fueled by significant gains in the tech sector. And this tech-driven surge hasn’t been limited to the US. Japan's Nikkei 225 index also marked another all-time high—up nearly 25% year-to-date—while South Korea's KOSPI reached its highest level since January 2022.

This widespread market optimism has largely been focused on semiconductor and AI-related companies—which might also pose a concentration risk, as we covered above!

However, it's worth noting that this enthusiasm isn't uniform across all sectors. For instance, the Dow Jones Industrial Average index—which is less tech-heavy than the S&P 500 or Nasdaq—has seen a far more muted performance so far this year.

Besides the AI hype, there are a few other factors currently buoying the markets. For one, while US inflation is still above the Fed’s 2% target, it is showing signs of cooling. There's now a growing confidence that the Fed might soon ease its tight monetary policy, with traders seeing a 70% chance of a rate cut by September.

These articles were written in collaboration with Finimize.

🎓 Simply Finance: Concentration risk

Think of your investment portfolio as a garden–concentration risk is like planting only one type of crop. If conditions are perfect, you might have a bumper harvest. But what if there’s a sudden heatwave? Your entire garden could be at risk.

In investing, concentration risk happens when too much of your money is in one company, sector, or asset type, which exposes you to outsized losses. Just as a diverse garden is more resilient, a diversified portfolio is better equipped to weather various market conditions.


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