What to make of the record market rally inviting more distrust than fear of being left behind? The S&P 500 has been at all-time highs for almost 30 days this year, four of them last week. The wealth of U.S. stocks has never been greater, and the index has been fairly smooth. For eight of the past 10 trading days, the S&P 500 has moved less than 0.3%. But investors are talking about how the rally is unreliable, lacks broad participation, and doesn’t reflect an ideal soft-landing economic scenario. That everyone is lamenting the lack of breadth of the rally doesn’t negate or dismiss the point. A big divergence in performance between the dense pack of big tech companies chosen as flagships of artificial intelligence and the thousands of others left behind is inevitable. And in fact, that’s the source of the small daily movements that violently counteract the currents that keep the index moving. The S&P 500 Index, with three stocks (Microsoft, Apple, and Nvidia) accounting for 20% of its market capitalization, has risen nearly 14% this year to an all-time high, but an equal-weighted version of the index is up just 3.4%, 4% below its late March peak. The S&P, the leading stock index, is up more than 3% in the second quarter, but its median is down 5% quarter-to-date. The broader Russell 1000 Index, made up of all large-cap stocks, is essentially flat year-to-date on an equal-weighted basis. .SPX mountain 2024-03-29 S&P 500 Index Quarter-to-Date The S&P 500 Index’s market capitalization has risen $5.5 trillion in 2024, with about half of that coming from the Big Three. The combination of sustained gains in the S&P 500’s leading stocks and further volatility in those below them has created a strange combination of the benchmark being overbought while most stocks are stagnating or correcting. The index appears to be stretched slightly to the upside, judging by how well it is performing above its 50-day moving average and other indicators. Meanwhile, less than half of the constituents are trading above their individual 50-day averages. Summarizing the asymmetric moves late Friday, Bespoke Investment Group suggested: “This week’s move felt like a blowout move, where investors have finally given up hope of small caps rallying and are reluctantly buying large caps that have already seen tremendous gains.” This is a plausible view, but it is impossible to support or refute with confidence. There is no one right way for markets to move. Sometimes a weak range reverses and closes the gap with large caps, and sometimes it portends a pullback for the index. Invariably, it frustrates stock pickers looking to outperform runaway benchmarks and robs the majority of investors of their confidence. Familiar market conditions? None of this is new. Over the past decade, we have seen “FANG” dominance, then “FAANMG”, “The Magnificent Seven” and now the “AI Elite”. Along the way, if the macro environment brightens or the policy outlook eases, an all-in rally suddenly comes into view to build a cushion of width for the coming months, as it did in 2017, 2020, and late 2023. Right now, this is a market plagued by a fundamental lack of conviction, and the largest companies are also the ones with the best long-term growth prospects, the healthiest future earnings trends, and the strongest balance sheets. The extreme examples of the multiyear theme cited by skeptics — large vs. small caps, growth vs. value, high quality vs. low quality — essentially measure this same preference. Market concentration is exacerbated when the “best” are also the largest. In other words, these are familiar atmospheric conditions. But the weather pattern for certain macro markets this month has shifted in a noteworthy way. Treasury yields have fallen dramatically, with the 10-year note dropping to 4.22% from over 4.6% on May 29, following a series of sluggish inflation measures and somewhat soft economic data. More recently, lower yields have meant wider spreads, providing some relief to financials, cyclicals and small caps. That hasn’t been the case so far in June, and the market has implicitly become more sensitive to signs that the economy is slowing more than the Fed and investors would like. Citi’s U.S. Economic Surprise Index indicates weaker momentum in domestic macro inputs compared to expectations. It’s by no means an alarming drop, but it has caught investors’ attention. It’s not entirely clear whether the Fed’s new headline rate outlook or Chairman Jerome Powell’s comments after last week’s policy meeting have prompted a fundamental reassessment of policy stance, but neither was a particularly clear outcome. Going into the Fed meeting, the market had implicitly priced in one to two quarter-point rate cuts by the end of the year. In the “dot plot” of committee forecasts, 15 of the 19 members had one or two rate cuts in sight. Since decision day, CPI and PPI inflation measures have shown encouraging signs. The Fed has kept overnight interest rates at cycle-high levels of 5.25%-5.5% for 11 months, an unusually long pause. During that time, the economy has performed better than expected, and inflation has fallen to close to the Fed’s target zone. So while the Fed is betting that the cost of waiting will remain low, the market is beginning to get impatient (though not panicked) at the idea that the Fed’s patience may outlast the economy’s ability to recover. The ideal, but by no means guaranteed, scenario would be that the Fed would find an opportunity to cautiously begin “discretionary” easing, rather than rushing into an emergency rate cut. All of this helps explain a somewhat indecisive market with weak investor support for economically sensitive groups. But if the market is sounding red alerts of an impending economic crisis, purely defensive sectors like consumer staples and pharmaceuticals would not look too bad. And as Strategas Research technical strategist Chris Bellone points out, corporate credit indicators remain healthy even if spreads have widened slightly in recent weeks. Fortunately, widespread unrest over the narrowness of the market has sapped crowd enthusiasm, and fears over the uneven rhythm of the tape are keeping a wall of worry. Wall Street strategists, as a group, are predicting no late gains for the S&P 500, with their averages and medians below Friday’s closing levels. The American Association of Individual Investors’ weekly survey shows that the gap between bulls and bears has narrowed recently, even as the S&P has risen. This is not to suggest that “everyone is bearish” in a way that would reveal a contrarian upside play, or that an undertone of caution will keep the market safe from difficulties as the summer progresses. The second half of June has been one of the toughest periods on the calendar in recent memory. Semiconductor stocks, which are leading the rally, are ridiculously overbought, and inflows into sector ETFs appear to be overheating. The frenzy and overheating around AI and stock splitting stocks has been substantial, albeit localized. As I have previously suggested here, the S&P 500’s 5-6% drop in April seems necessary, but it may not have been the cleansing flush that could have produced a new, more energetic and comprehensive uptrend. The turmoil beneath the index’s surface since then may simply be the market’s way of refreshing itself over time. Still, it’s hard to give the bears the benefit of the doubt, given that second-quarter S&P 500 earnings growth is now projected at 9% annualized, the vast majority of stocks are still in long-term uptrends, Treasury yields are back at reassuring levels, and average stocks and investor attitudes have calmed considerably.
