S&P 500 begins June near record high but with growing concerns about narrow market leadership

The stock market is not a democracy. But observers nevertheless like to warn gravely that a lack of broad participation by the majority of voters can create a leadership crisis. Yes, investors are once again starting to worry about the relative narrowness of the last phase of index progression. The S&P 500 is just 1.2% off its all-time high, but only 60% of its members' stocks are up for the year and just over 40% last week were above their 50-day moving average. .SPX YTD mountain S&P 500, 1 year We seem to go through one of those periods of decrying the lack of breadth in the market every few months over the last few years. Last year, the Magnificent Seven brand grew thanks to the way these huge growth leaders dominated market returns following the SVB's financial collapse and credit scare. In an ideal scenario, rallies would be largely inclusive, if only because a strong preponderance of rising stocks implies strong demand for equity exposure and a sense that fundamental and/or financial conditions are improving widely. But do the facts show that a more selective approach, supported by a relative handful of big winners, is inherently more dangerous, or a prelude to future market crashes? Is width important? It's not entirely clear that this is the case. Bespoke Investment Group looked last week at the small number of past instances where the S&P 500 was so close to a record high while most stocks were below a 50-day average. Gains in the index followed more than 70% of the time between one and six months. Although one-year returns were below average, they varied between an increase of 19% and a decrease of 13%. In a bull market, width divergences more often resolve to the upside, with most stocks recovering to sync with the index, although this is far from a guarantee. Last year, a very similar pattern of slowing internal momentum set in around mid-year, before a broader rally took the S&P to new highs over the summer (culminating by a minor peak at the end of July followed by a correction). as shown in this graph. Warren Pies, founder of 3Fourteen Research, has analyzed how markets have evolved following other conditions that have emerged over the past week, including the so-called Hindenburg Omen (an extreme accumulation of new highs and lows over 52 weeks) and the nasty downside reversal after Nvidia's earnings report, when Nvidia (among the top three weightings of the S&P) jumped 9% and yet the index fell 1% on the day. Nothing as clear as an unambiguous manual emerges, but the incidence of a significant correction in subsequent months has been higher than usual. However, Pies chose not to recommend reducing equity exposure, noting that "sentiment and positioning do not resemble market highs" and that "profit breadth is widening and momentum signals from the beginning of this year remain intact. Nvidia's influence Last week's erratic and arrhythmic market action largely reflects two trends indicative of the current operating environment: Nvidia's extraordinary, almost singular behavior and the way the stock market metabolizes movements in Treasury yields these days. Of the $4.2 trillion in market value gained by the S&P 500 index since the start of the year, Nvidia (now with a 6.2% weighting) alone contributed $1.5 trillion, or more than a third of the total. The stock regularly trades for a volume in dollars that represents several multiples of the turnover of Microsoft, Apple, Tesla or Amazon. It is consistently the most active call option contract. The GraniteShares 2X Long NVDA ETF – which offers twice the daily change in Nvidia shares – saw its assets climb to $2.8 billion, up from $200 million five months ago. Rapid, high-velocity money flows into and out of the third-largest stock by market cap in the world, a stock that is 120% more volatile than the S&P 500 itself, is a formula for unusual gyrations and asynchronous. evolves among the indices and the majority of stocks. The 100-day correlation between the S&P 500 and the Dow Jones Industrial Average has reached its lowest level since the dot-com collapse of the early 2000s, according to CNBC's Data & Analytics group. The Dow, of course, is missing Nvidia. One can decide whether such a concentration of energy and capital in one name is a good thing, a dangerous thing, or just something that is. Certainly the enthusiasm around Nvidia and a small number of direct beneficiaries of AI and industrial infrastructure building reflects the current lack of strong fundamental beliefs. Impact of rates This is where the Treasury yield factor comes into play. As yields rise (on the back of persistent inflation, solid growth, and a scrupulously patient, data-dependent Fed), as they did for two weeks starting May 15, the majority stocks are falling and money is migrating to the huge secular growth names impervious to macroeconomic oscillations. and the cost of capital. Banks and small caps are falling, consumer cyclical stocks are under pressure. The way this market plays defense is to inflate the premium on proven new economy winners – who also happen to be among the most expensive, fast-growing, and busiest games on the market. The one-day implosions of Salesforce.com and Dell Technologies after their profits showed they weren't sufficiently leveraged in the face of the AI building bonanza (at least in investors' knee-jerk response ) reinforce this impulse of the crowd to hide on a thinner patch of perceived security. secular themes. Citi equity strategist Scott Chronert suggested Friday that all this shows: "Pockets of the market could depend on consistent beat and rise momentum throughout the year to justify current prices." At the level of the index, the rise in rates since the start of the year intensifies this pressure. It is however important to consider that the slight decline of around 2% compared to the peaks of the MTD was accompanied by a increased consensus EPS expectations for full year 2024, which are now in line with our guidance. We view this as a healthy, crushing price development. pockets of exuberance where prices have outpaced a still strong fundamental trend. Indeed, earnings forecasts for 2024 have shown unusual resilience in recent months, avoiding the usual downward revision trajectory, as this chart from UBS illustrates. When yields pull back – as happened last Thursday and Friday, with the help of a benign PCE inflation number – the magnitude has improved, financials, cyclicals and stocks of Smaller companies have enjoyed some relief, and anticipation of a broader earnings recovery and perhaps a Fed rate cut has lifted most boats. . Tape Refresh During the final quarter of an hour of trading Friday, as if the machines had heard enough about worrisome bad news, a blind bid sent nearly every stock vertically higher, allowing the S&P 500 to gain 0.8% – with 80% of all members higher – and reduce the index's weekly loss to just half a percent. These are of course mechanical maneuvers linked to the cleaning of end-of-month reallocations and a quarterly rebalancing of large volumes of the MSCI indices, most of which is carried out at the close. None of this means the action was illegitimate or over-the-top, just that it will need to be tested by human decision-makers in early June. I'd boil it all down to a fully valued market that, after a historic seven-month sprint, hovered for two months not far from record highs, with the majority of stocks retreating noticeably in a stealth reset. Profits and continued economic expansion are key supports. Credit indicators mostly flash green. Traditional defensive sectors such as consumer staples and pharmaceuticals showed no vitality, a decent macroeconomic message. The S&P 500, at its peak, hit 21 times forward earnings, and we've spent very little time above that number outside of the pandemic crisis and tech boom/bust a year ago. quarter of century. Investor sentiment and positioning may not be at scary extremes, but they also weren't completely wiped out in the April pullback, leaving them rather full. And the acceptable data trajectory for the bulls is not that wide, necessitating clear further progress on disinflation while any deceleration in the economy does not tip into stall speed. Given this, it would not be surprising if it takes time, slowing stock prices and rising earnings prospects (are we already trading based on 2025 estimates from the middle of the year?) to refresh the tape.