In the face of banking stress and a hawkish Federal Reserve, stocks have advanced impressively so far this year, but narrow breadth doesn't bode well for continued strength.
If all you knew were the facts in the list below, what might the most logical conclusion be in terms of the stock market's performance? In just the past few months, we've seen:
- The second and third largest bank failures in U.S. history;
- The Federal Reserve continue its most aggressive tightening cycle in decades, bringing the fed funds rate to the highest since 2007;
- Core PCE inflation (year-over-year) move from 4.7% in January to 4.6% in February, still well above the Fed's target;
- The two-year U.S. Treasury yield slide from a high of 5.07% in early March to a low of 3.55% just a few weeks later (the fastest drop of that magnitude since October 1987).
Conventional wisdom and simple logic might suggest the above list paints a dire scenario for the market. Yet, the S&P 500 finished higher by 3.5% in March, while the Nasdaq jumped by 6.7%. That brought first quarter (and year-to-date) gains for both indexes to 7% and 16.8%, respectively. Some have cheered a "new bull market" for mega-cap tech/growth indexes (like the Nasdaq 100) that have climbed by more than 20% from their December low; while bears have pointed to the lack of participation down the cap spectrum (the Russell 2000 has gained only 2.3% year-to-date) as a building risk.
To give some credence to the bears' argument, it is noteworthy that the market's recent rally has looked incredibly anemic when it comes to participation. That can be shown in numerous ways, the first of which is the performance of the S&P 500 equal-weight index relative to its cap-weight counterpart. As you can see in the chart below, the ratio has plunged so far this year, eliminating much of the edge equal-weight had until recently. A short look back at the past two bear markets shows that a steep drawdown in this ratio is consistent with acute pain in the broader market. This time, it's much more about the outperformance of larger members as opposed to massive losses for the rest of the crowd.
All else is not equal
Source: Charles Schwab, Bloomberg, as of 3/31/2023.
Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. Past performance does not guarantee future results.