This is the gist of today’s Morning Briefing. sign up Get the following in your inbox every morning:
Major stock indexes may have only made modest gains on Wednesday, but the soldiers were marching on while the generals were sleeping.
Leading the way, small declines in big energy and financial stocks were offset by big gains in the consumer discretionary sector, mainly led by Amazon (AMZN) and Tesla (TSLA).
This see-saw theme has been a subtle but important market story: On days when AI isn’t in charge, select strength has prevented the S&P 500 from plummeting, which itself has kept the index’s volatility at multi-year lows.
Nvidia’s recent “plummet” is instructive.
On Monday alone, the flagship AI stock closed 13% down from its all-time high. If you look at social media, it looks like Wall Street is on fire.
But a funny thing happened during that disastrous three-day slump: The Dow Jones Industrial Average (^DJI), up just 3% this year (vs. 14% for the S&P 500), bounced back. Energy stocks thrived, and biotech stocks soared as a forgotten part of the market came back to life.
This see-saw effect is now ubiquitous as an alternative to correlation between stocks in similar sectors: stocks simply do not want to move in the same direction.
“This is a generationally strange U.S. stock market,” wrote Luke Kawa, former director of investment solutions at UBS Asset Management Americas and now at Sherwood Media.
Kawa was specifically referring to Tuesday’s performance, in which the S&P 500 rose just 0.4%, a new record in data stretching back to 1996, even as 384 of its components closed lower.
Similar “firsts” have been dotting market statistics recently.
But this doesn’t undermine the well-researched and historically supported argument that during bull markets, it’s entirely normal for profits to be concentrated in a few stocks.
Winning stocks that enjoy a long-term thematic upswing will grow bigger and bigger until the move runs its course.
In a bull market, when a major stock stalls, other parts of the market that aren’t making the headlines are able to step up. Sector rotation allows new winners to offset losers, keeping index level volatility low. Then, at some point, the music stops, all sectors start selling in unison, and a new bear market begins.
Kawa connects this to the current market, writing, “Various major groups within the U.S. stock market have been going at their own pace recently, and this dynamic is preventing the stock market from falling too sharply.”
Now, we’re seeing differential returns not just across sectors and industries, but within sectors and industries, even among mega-cap tech stocks. Over the past six months, when some stocks, like Microsoft and Alphabet, rise, Nvidia and Apple can fall. The directional correlation between the two stocks in this group is just 43%, Kawa noted.
These zigzags keep index-level volatility in check, but Kawa cites “correlation shocks” diversified “among the companies that control many of the U.S. and global equity indexes” as the main risk in this environment.
While a “big selloff” remains the central risk, the divergence could last longer than arbitrage investors can remain solvent (to borrow an old Wall Street phrase).
In fact, research from Bank of America’s data analytics team suggests that the current climate of low inter- and intra-sector correlations may continue for years to come.
“Several years of de-correlation during the growth of the Internet bubble in the 1990s suggest that the survival of today’s regime remains a risk,” Bank of America wrote.
So a big divergence in revenue between a select few AIs and the rest of the market doesn’t have to end with much ado.
“Just because you’re in uncharted waters doesn’t mean you’re heading for a waterfall. You might end up in a lazy river,” Kawa wrote.
For the latest stock market news and in-depth analysis, including stock-moving events, click here.
Read the latest financial and business news from Yahoo Finance
