Tale of the Tape

You have to be a very attentive student of the stock market to understand just how unusual this year has been. The year isn’t over yet, so much can change from now to the end of the year, but what has happened thus far is startling.

If you read these pages regularly, or read the financial press, you have heard of the ‘Magnificent Seven’ – the 7 large cap tech stocks that have accounted for most of the stock market performance this year. Market breadth has improved recently with the resurgence of oil prices and energy stocks, but the extent to which the stock market has relied on relatively few stocks to produce the outstanding performance of the S&P 500 this year is actually quite astonishing.

The chart below indicates the percent of S&P 500 stocks that outperformed the entire index each year, but you need to take a minute and think about this chart. In bad years, like 2008, almost half of the stocks outperformed the index. In strong recovery years, like 2009 and 2010, we get a high 50% number of outperforming stocks.

The percentage is actually relatively stable until the pandemic of 2020. After a sharp, but brief, market decline, stocks came roaring back as the government throw money at the problem, but the market was dominated by a fairly small band of mostly tech stocks that actually benefitted from lockdowns. Despite a strong stock market performance in 2020, only 36% of stocks outperformed the index, which at the time was considered an extreme event.

Thus far, 2023 is even more extreme as the S&P 500 Index has registered a roughly 16% gain this year, yet only 27% of the stocks are outperforming the index! The chart makes it rather obvious how far from normal this performance is and how reliant the stock market has been on a small number of stocks. The lack of broad market participation in 2023 to date is nothing short of extraordinary.

Does Market Breadth Matter?

The 7^th of Bob Farrell’s 10 rules states that “Markets are strongest when they are broad — and weakest when they narrow to a handful of blue chip names.” Market breadth is considered strong when many more stocks are advancing than declining and likewise, breadth is weaker as that trend reverses. The chart below is the Advance/Decline line for the NYSE, which is a simple measure that simply subtracts the number of declining stocks each day from the number of advancing stocks.

As you can see on the chart, market breadth in 2022 was not strong, and while it has recovered a bit 2023, largely on the back of higher oil prices/energy stocks, we have not returned to a strong trend.

There is ample debate about whether breadth makes difference this time around. We tend to think it does, as these rules are formed over many years and generally, they do not cease to function. Nonetheless, the current situation is quite muddled. The A/D line is indeed rising, but the number of stocks outperforming the index level is extraordinarily weak.

What is clear is that the current environment cannot be sustained. One way or another, this has to be resolved. Either breadth picks up and the market gets stronger or the few stocks leading the S&P 500 Index performance run out of gas and the stock market weakens.

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By: thinkhouse