FAS Market Update June 2024

The Markets’ Narrow Rebound

Another NBA season has ended with the Denver Nuggets winning the title for the first time in their 47-year history.  In an unusual twist, many of our local clients likely found themselves rooting WITH the city of Denver as their alma maters were well represented by Christian Braun (Kansas) and Michael Porter Jr. (Missouri). Who could resist cheering on the humble star Nikola Jokic with his supreme dominance in all facets of the game throughout the playoffs?  Casual observers of the NBA would be forgiven if they could not name a player on the Heat’s roster besides their star Jimmy Butler.  Although Miami, led by Buter, had an impressive surge through the playoffs, Denver’s broader player contributions were eventually too much to overcome in the finals.

In many ways, the recent bull market rebound is life imitating the art of team basketball.  If the Denver Nuggets are a broad-based increase in equity prices, then this year’s rise in stock prices could be considered the Miami Heat with returns dominated by stars such as Apple, Nvidia and Meta.  In investment terms, the recent “star player” appreciation is known as narrow breadth.

Market breadth is considered a technical indicator which is a technique to obtain information by observing trends in market prices.  There are a variety of ways to measure breadth, the broader the breadth the better although narrow breadth is not a surefire indicator of poor future returns.  Generally, our investment focus at FAS is on the fundamentals of markets and economics but the concentrated short-term performance of a narrow subset of stocks through 2023 is worth taking note of.

Very large technology stocks were the unanimous MVP to begin the year.  The chart below graphs the average return of the five largest stocks in the S&P 500 as of June 8, 2023.  Their prices have jumped an average of 47% compared to the total return of 13% for the overall index.  Importantly, the other 495 stocks within the index are not performing up to the average with a mere 5% return over the same period.  This return dispersion is an indicator of weak or narrow market breadth although the gap has slightly closed during the month of June.  It remains to be seen whether the rest of the index will get in the game and “catch up” to the Mega cap tech names or if that small group of stocks tire and “catch down”.  Or as we tend to believe, a combination of the two.

The Mega cap tech names are categorized by sector according to their business models similar to a player’s position on the basketball court.  Their weightings dominate the information technology, communication services and consumer discretionary sectors.  Another way to understand the narrow market breadth and sheer magnitude of the outperformance is comparing by sector results. On a price basis, the S&P 500 is up 11.84% as of June 8, 2023, with the aforementioned sectors outperforming by a wide margin.  In fact, more than half of the sectors within the S&P 500 are flat to down to begin the year.

Not only are these Mega cap tech stocks the MVP for the first half of 2023, but they are also the comeback players of the year.  During the bear market of 2022, some of the most severe drawdowns were experienced by these stars which are shining brightly now.  The table below quantifies the dramatic drop in prices experienced with stocks such as Facebook (META) and Netflix down over 75% from their 2021 peaks!

The final chart illustrates how poorly most of the approximately 500 stocks have performed over the trailing 60 days relative to the index.  Only 15% of the stocks outperformed the index through the end of May, which demonstrates the weakest market breadth observed going back to 1993, worse than 2000 and 2020, yet another indication of how concentrated returns have been to start the year.  An encouraging sign for market breadth is the improvement in this measurement during the month of June. The percentage of outperformers has increased to 24%.

To summarize, the positive US equity returns to begin 2023 have been dominated by a small subset of very large technology focused companies which defines narrow or weak “market breadth.”  These episodes do not necessarily portend an imminent reversal in returns, but it is not an indication of a healthy market environment either.  At some point investor enthusiasm will fade and those star stocks will lose steam providing an opportunity for broader relative stock contribution.  Our purpose as advisors is to not rely on a handful of stocks to generate returns to meet your long-term goals.  Rather, we build a broad lineup of investments which provide time-tested risk reduction over the long-term while substantially reducing volatility.

This month’s analogy inspires us, and we didn’t even touch on the Serbian born Jokic’s origins and the benefits of his international influence.  For our K-State friends out there, we have not forgotten about you.  We hope to be writing an update about Markquis Nowell and the benefits small caps can provide for portfolios next year.  Again, congratulations to the Denver Nuggets fans on a fantastic season!  Finally, a gentle reminder that NFL training camps are only a month away… Go Chiefs!

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