To The Moon

The S&P 500's recent record highs are being driven by a narrow group of leading stocks, with analysts warning that a potential downturn in the AI sector could lead to a broader index decline, likely starting in June, even if smaller stocks recover.

The S&P 500 has repeatedly set new all-time highs, but this performance masks a concerning underlying trend: the rally is being fueled by a very small number of stocks, with most components failing to participate.

Ned Davis Research strategist Rob Anderson noted on social media platform X that the percentage of S&P 500 constituents outperforming the index over the past two months is the third lowest since 1972, indicating an unprecedented level of market divergence.

BTIG Chief Market Technician Jonathan Krinsky argues that the index's gains are highly dependent on leading AI stocks. He warns that if these heavyweight stocks reverse course, the broader market could come under significant pressure, with a likely turning point arriving in June.

While the S&P 500 notched its ninth consecutive daily gain on Tuesday and is on track for a tenth weekly advance, underlying market breadth paints a less optimistic picture. The index has experienced six straight trading days where it closed higher despite more of its component stocks declining than advancing.

Krinsky stated in a Tuesday report that, based on data since 1996, the S&P 500 has never before seen six consecutive days of index gains paired with more declining than advancing stocks each day. Previously, this anomalous pattern had lasted no more than three days.

This market characteristic signifies an increasing reliance on a handful of high-weight stocks. Krinsky terms the resulting split between a rising index and weakening majority of stocks a "breadth paradox": even as most market sectors weaken, top-weighted stocks can still single-handedly prop up the index.

During periods when leading stocks continue to rally, the S&P 500 can climb steadily even as most components underperform. However, if this concentrated rally falters and the momentum in heavyweight stocks fades, the extreme concentration could work in reverse, dragging down the broader index. A recovery in small and mid-cap stocks might not be enough to prevent a decline.

"When a sustained concentrated rally finally reverses, we could see a scenario where individual stocks broadly rise while the major indices fall. We maintain our view that June could mark the beginning of this reversal," Krinsky added.

The concentration in the current US stock market is stark. The information technology sector's weighting has climbed to nearly 40%, a record high for the S&P 500. Similarly, the combined market capitalization of the index's top ten holdings accounts for roughly 40% of the entire index.

Data shows that over the past five trading days, only two market sectors closed in positive territory: the technology sector surged 5.9%, and the energy sector gained a modest 0.3%. Meanwhile, real estate, utilities, and communication services sectors all fell more than 3%.

Historic Two-Month Surge Over 16% Raises Echoes of 1987 Crash Warnings

Setting aside factors like AI sector sentiment and geopolitical tensions involving Iran, the S&P 500 has delivered one of its strongest two-month rallies in history. Data from Deutsche Bank Research shows the index gained over 16% in the two months leading to the end of May.

Jim Reid, Head of Global Macro and Thematic Research at Deutsche Bank, commented via email: "This rate of ascent is in historically rare territory. Since World War II, there have only been four other instances of a two-month surge of this magnitude."

Reid further analyzed the historical context: three of those previous surges occurred during market recoveries following economic recessions, corresponding to the period after the 1970s oil crisis, the end of the 2008 financial crisis, and the initial phase of the COVID-19 pandemic. The sole remaining instance of a rapid, non-recessionary surge, however, happened just before the Black Monday crash of 1987—a comparison that carries a significant warning.

Historical records show that ahead of the 1987 crash, the S&P 500 had gained nearly 39% year-to-date by August, highlighting market valuation bubbles. At that time, the Federal Reserve was in a rate-hiking cycle, and the market was gripped by fears over trade and fiscal deficits.