Will The Fed Expose This Underlying Market Weakness?

Hey Traders,

With the recent market volatility, now might be a good time to ask …

What’s really going on here?

Yes, we are seeing some selling …

But the S&P 500 (Ticker: SPX) is not far off record highs.

Here’s the thing …

The strong SPX performance doesn’t speak for the whole market …

And the underlying weakness may be more widespread than we’d like to believe.

What is really important to pay attention to is exactly which names are powering these gains.

Right now, we are seeing pretty terrible market breadth. 

“Market breadth” refers to how many stocks are going up, and how many stocks are going down.

Currently, we are seeing negative breadth, which means more stocks are losing than are gaining.

We are seeing most of the market gains, and these ‘all time highs,’ powered by just a handful of mega-caps … while smaller companies are being left behind.

In fact, just five names are responsible for 51% of the S&P 500’s gains since April: Microsoft (Ticker: MSFT), Alphabet (Ticker: GOOGL/GOOG), Nvidia (Ticker: NVDA), Apple (Ticker AAPL), and Tesla (Ticker: TSLA).

That’s not great.

That means many of the other 495 names in the S&P 500 are trending neutral-to-lower … and the number of “losers” is continuing to grow. 

When looking at the SPX versus the Russell 2000 (Ticker: RUT), you can see this being played out.

The S&P 500 consists of 500 large-cap companies (companies valued at greater than $10 billion). It’s largest holdings consist of the names above.

Meanwhile, the RUT consists of 2,000 smaller companies (the smallest 2,000 companies of the Russell 3000). It’s top holdings include AMC Entertainment (Ticker: AMC), Asana (Ticker: ASNA), Crocs (Ticker: CROX), and Ovintiv (Ticker: OVV).

Both the SPX and RUT are cap-weighted, meaning companies with larger valuations hold more weight in the index.

Take a look at the SPDR S&P 500 ETF (Ticker: SPY) year-to-date:

Chart courtesy StockCharts

Now compare that to the iShares Russell 2000 ETF (Ticker: IWM) year-to-date):

Chart courtesy StockCharts

Notice how IWM’s uptrends have been more subdued, while the moves lower have been even more exaggerated.

The overall upside the IWM has seen is notably smaller than the incredibly strong performance of the SPX.

This is because in spite of our string of all-time highs, market breadth is simply not there. There is not a widespread abundance of gains … rather they are being concentrated into a handful of mega-caps, which are disproportionately powering the S&P 500 higher.

Why is this problematic?

Simply put, it is not sustainable.

And it puts us at the mercy of mega-caps.

If we see one sneeze … the whole market could come tumbling down.

Think about the ARK Innovation ETF (Ticker: ARKK) effect.

We just saw what heavy selling in a handful of heavy-hitters could do to the market.

And with the Fed set to accelerate its tapering measures and increase interest rates, tech stocks could face headwinds. Higher interest rates and inflation both weigh on high growth stocks, especially those with frothy valuations who will see earnings impacted and loan interest increase.

Some companies may have the power to pass these rising costs onto consumers, but others will end up shouldering much of the burden themselves.

When more than half of the market is being boosted by gains in just five names, a stumble out of even one could cause outsized ripples …

And with the negative market breadth we’re seeing now, there won’t be a bevy of other names there to pick up the slack.

Your Only Option,

Mark Sebastian

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