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Does Narrow Breadth Threaten The Market Rally?

Michael Brown
Senior Research Strategist
31 May 2023
US equities have been performing well of late, with the S&P 500 trading at its best levels since last summer, and the tech-heavy Nasdaq having rallied to its highest in just over a year. Despite this, much has been made of the narrow breadth indices have been exhibiting, as well as the outperformance of US markets compared to DM peers, though markets continue to shrug off the plethora of bearish arguments for now.

The ‘wall of worry’ that riskier assets must climb is a large one – including a range of factors such as the fallout from the debt ceiling resolution, the possibility of further Fed tightening, slowing economic momentum, slower earnings growth, and many more issues besides. However, thus far at least, the stock market has been able to deftly navigate these potential hazards.

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Having been trapped in a relatively tight range since last summer, the S&P has finally made a closing break above 4,200, holding the level on a re-test, implying that we may at long last be about to breakout of what has been a painfully long rangebound spell.

The tech-heavy Nasdaq tells a similar story of breaking out of the range that has held for some time, with the index having embarked on a rather aggressive uptrend, albeit one that looks to have begun consolidating just shy of longstanding resistance at 14,500.

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Despite the unarguably bullish price action, supported by the aforementioned technical breakouts, there are plenty who don’t want to believe the rally. Chief among the bears’ concerns appears to be the lack of breadth – i.e., the idea that the rally is being fuelled by a small number of stocks, with the majority of an index’s constituents not joining in with the headline gains.

The S&P’s performance evidences these concerns, with just 179 of the 503 constituents (approx. 35%) having delivered a positive return over the last three months, despite the broader index having gained 6% over that period. A similar theme is evident on a year-to-date basis, with the S&P’s outperformance over an equal-weighted version of the index being the vastest since the late-90s.

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As with the last time similar concerns were raised over narrow market leadership, we again see ‘big tech’ leading the way higher, with the sector having gained almost 35% YTD, along with a 32% gain for communications, compared to a roughly 10% gain for the index as a whole.

Of course, there are some idiosyncratic factors at play here. Nvidia, for instance, the S&P’s best performer this year, has been seized upon by traders as the best way to capitalise on the AI frenzy currently sweeping financial markets, having now become only the 9th firm in history to eclipse $1tln in market cap. Although Q1 earnings were, once digging into the release, rather subpar (revenue down 13% YoY, EPS down 22% YoY), the buying frenzy has continued.

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The AI mania, which kicked off with the release of ChatGPT last November, has some similarities with the blockchain frenzy from a few years ago. In terms of media traffic, at least, we are still some way off that particular episode, though the utility of each is probably similar at this stage.

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For traders, however, the key question is whether narrow market breadth poses a major risk to the broader market rally. Markets have been able to shrug off periods of minimal upside participation in the past, and look set to do so once more.

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