The recent climb of U.S. stocks to new highs has been driven by a very small number of equities, reminding some Wall Street observers of the period preceding the internet bubble. Although the comparison requires caution, given that the large-cap stocks currently leading the market are posting substantial profits, the narrow market breadth continues to worry many investors and analysts. Among them is Ben Snider, Chief U.S. Equity Strategist at Goldman Sachs. "If you look at the S&P 500, it's at a record high, but the median stock in the index is still about 13% below its own high," Snider said in an interview on Tuesday. "This is one of the widest disparities in about 25 years. From a market perspective, it does send some warning signals." In four of the S&P 500's last five record closing highs, the number of declining stocks exceeded the number of advancing stocks. Strategists at BofA Global Research noted that in April, only 23% of S&P 500 constituents outperformed the index, marking the fourth-lowest monthly reading in their data history dating back to 1986. Snider is not alone in expressing caution. "Do not mistake a narrow rally at record highs for broad-based strength," said Mark Malek, Chief Investment Officer at Muriel Siebert & Co., in a telephone interview. He described the narrowness of the current advance as "unsettling," pointing out that market breadth has fallen to "one of the lowest levels in decades, excluding the internet bubble period." Strong profit growth from semiconductor firms and large technology companies like Alphabet Inc., Google's parent, has propelled the benchmark index higher. However, Malek noted that these record highs are effectively being achieved by just a "spearpoint" of stocks, referring to a small group of companies associated with artificial intelligence. For Goldman's Snider, the narrowness of the market rally reflects a similar concentration in upward revisions to S&P 500 earnings estimates, led primarily by semiconductor, technology, and communication services companies. "Sharply narrowing market breadth has historically often preceded equity market pullbacks," Snider wrote in an April 30 report. Analysis from Goldman Sachs shows that since 1980, the S&P 500 has experienced an average pullback of 10% in the 12 months following a sharp decline in breadth. Rob Anderson, U.S. Sector Strategist at Ned Davis Research, noted in an April 30 report that since October, leadership in U.S. stocks has rotated frequently—from technology to defensive sectors, then to energy, and back to technology—which has "hindered a broad-based cyclical recovery." Beyond the breadth issue, Anderson also pointed out that only 6 of the 11 major sectors in the S&P 500 are within 5% of their all-time highs. The S&P 500 Equal Weight Index has not reached a new closing high since the onset of the Iran conflict. "Many stocks are just churning sideways or making minor gains, while the technology and semiconductor sectors are seeing significant advances," said Jonathan Krinsky, Chief Market Technician at BTIG LLC, in a phone interview. Another similarity to the internet bubble era is that only 53% of S&P 500 stocks are trading above their 200-day moving averages. Krinsky stated that for a market that has risen more than 12% in 23 trading sessions, this proportion is relatively low, comparable to similar rallies in 1999 and 2000. "We don't think the current situation is exactly like 2000, but the internal breadth within the S&P 500 is indeed weaker than what bulls would prefer to see," Krinsky said. The most significant difference between the current market and the internet bubble period lies in corporate earnings: today's market leaders are also the companies with the fastest profit growth, unlike the speculative, often unprofitable favorites around the turn of the century. "This isn't a Pets.com situation," said Muriel Siebert's Malek, referring to a famously unprofitable company from the internet bubble era. Nonetheless, he stated that the combination of narrow breadth and rapid gains makes him more cautious about stock selection in a market where valuations are starting to appear elevated again. "Recent similarities are intriguing and remind me more of the internet bubble," he said. "It looks like the familiar signs of a bubble that I've experienced during my time on Wall Street." The issue of narrow market breadth is not only a concern in the U.S. but also a global phenomenon. However, not everyone views it as an ominous sign. Strategists like Mislav Matejka at JPMorgan believe that global equity markets have been so concentrated in their rebound from the lows following the Iran conflict that even slightly positive news could trigger a broader rally. Goldman's Snider also acknowledges this possibility, but contingent on positive developments regarding the Middle East situation and energy markets. "If the war situation continues to improve, if energy prices decline, then the base case should be a broadening out of earnings and market performance," Snider said in the interview.
Comments