By David Randall
NEW YORK (Reuters) - As the S&P 500 has soared to fresh highs, fewer stocks have been participating in the rally, stirring worries that recent gains could reverse if the market’s leaders stumble.
Strong market breadth, or the number of stocks taking part in a broader index’s rise - is often viewed as a healthy sign by investors as it shows gains are less dependent on a small cluster of names.
Market breadth was narrow for most of 2023, with the 24% gain in the S&P 500 driven primarily by the so-called Magnificent Seven, a group of heavyweights that includes Meta (NASDAQ:META) Platforms, Apple Inc (NASDAQ:AAPL). and Amazon (NASDAQ:AMZN).
Breadth improved toward year end, yet some measures show it narrowing once again in 2024. For example, while the S&P 500 is up 5.4% and closed on Friday at a record high, the 10-day average of stocks on the New York Stock Exchange and Nasdaq hitting new highs has fallen to its lowest level since July, data from Hi Mount Research showed.
At the same time, only 62% of large-cap stocks stood above their 50-day moving average as of Thursday’s close, down from 87% in December, data from Thrasher Analytics showed. Meanwhile, the Magnificent Seven have accounted for nearly 60% of the S&P 500’s gain this year, according to Dow Jones Indices.
"We are at a historic extreme in the amount of money in this very small number of stocks," said Michael Smith, a senior portfolio manager at AllSpring Global Investments.
The narrow group of stocks powering the market could make it more vulnerable to swift declines if an earnings disappointment or other issue hits its biggest stocks, said Smith, who owns shares of Microsoft (NASDAQ:MSFT), Amazon and Google-parent Alphabet (NASDAQ:GOOGL).
While most of the megacaps have powered higher this year, shares of Tesla (NASDAQ:TSLA) have fallen 22%, the third-worst performer in the S&P 500, demonstrating how quickly the market’s superstars can fall out of favor.
Some investors believe breadth has narrowed partly because markets now anticipate the Federal Reserve will cut rates later in the year than many on Wall Street had expected, forcing an unwind of bets in rates-sensitive sectors that could benefit from lower borrowing costs.
The S&P 500 real estate sector, for instance, is down 4.4% year-to-date due to worries about commercial real estate. The Russell 2000 index of small cap companies is off 0.8%.
"You had a great rally in some areas of the market that had been really oversold, in anticipation of the Fed moving quickly in 2024 to cut rates," said Ed Clissold, chief U.S. strategist at Ned Davis Research. "Now that the market has changed its stance, people are rethinking how much these beaten down areas should rally."
Fed Chairman Jerome Powell last month shot down hopes for rate cuts as soon as the March meeting, saying the central bank needed more confidence inflation was headed back towards its 2% target.
Overall, markets late Friday were pricing in cumulative interest rate cuts of around 110 basis points by the Fed's December meeting, down from more than 160 basis points in cuts anticipated at the end of 2023.
Investors are awaiting next week’s U.S. consumer price data to see if recent strength in the U.S. economy is sparking an inflationary rebound that would likely force further reining in of rate cut bets.
There is an argument for sticking with the market’s biggest companies, which often have above-average growth and strong balance sheets. Since 1999, the top 10 companies by weight in the S&P 500 have returned an average of 12.3 percentage points more than the broader index, data from Dow Jones Indices showed.
At the same time, some strategists believe a longer-term look shows that more stocks actually have participated in the rally. More than half of the 100-plus sub-industries in the S&P 500 are up by 20% or more since the current bull market began in October 2022, analysts Yardeni Research wrote. Technology and communications services are the only ones to have outperformed the broader index, however.
"A few stocks have greatly outperformed the laggards, but many of the laggards likewise have done very well—just not as well," the firm wrote.