Hard to Concentrate: Top-Heavy Market

Supersized returns

Source: Charles Schwab, 22V Research, as of 6/14/2024.

The size factor is based on market cap and fundamental size such as sales, asset, and enterprise value. A higher size score means a larger size of the stock and underlying company. Correlation is a statistical measure of how two investments have historically moved in relation to each other, and ranges from -1 to +1. A correlation of 1 indicates a perfect positive correlation, while a correlation of -1 indicates a perfect negative correlation. A correlation of zero means the assets are not correlated. Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. Past performance is no guarantee of future results.

The dramatic outperformance of a small handful of stocks at the very upper end of the market capitalization spectrum has greatly flattered index-level performance among cap-weighted indexes. On the other hand, there has been a tremendous amount of churn and rotational corrections occurring under the surface. Cap-weighted indexes having performance biased by a small number of mega-cap stocks is not historically abnormal; but when the "rest" of the market is sorely behind, concentration risk becomes more acute. As shown below, only 17% of the S&P 500's members have outperformed the index itself over the past year; although the percentages are better for shorter periods, there is no period within six months having more than 26% of stocks outperforming the index. It's even more extreme within the Nasdaq; with only 11% of its members having outperformed the index over the past year and the largest percentage over the past six months is only 18% (over the past three and four months).

Source: Charles Schwab, Bloomberg, as of 6/21/2024.

Trading days used in calculations. Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. Past performance is no guarantee of future results.

Another way to express this concentration phenomenon is by comparing the index change with the change in the cumulative advance-decline data. Shown below, for both the S&P 500 and Nasdaq, the indexes have been powering higher, but that's alongside deteriorating breadth as measured by the number of advancing vs. declining stocks within each index on a cumulative basis.

Halitosis

Source: Charles Schwab, Bloomberg, as of 6/21/2024.

Cumulative advance/decline (A/D) line is the cumulative sum of the daily difference between the number of stocks on the New York Stock Exchange (NYSE) advancing and declining in a single day. Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. Past performance is no guarantee of future results.

Per always-insightful analysis by our friends at Bespoke Investment Group (BIG), there have not been many examples of this amount of divergence in breadth and price since the turn of this century. However—and this will probably shock no one—the 1990s had similar divergences on multiple occasions. In fact, the occurrences throughout the 1990s were actually characterized by far weaker breadth than what we've seen recently. The history lesson from the 1990s experiences suggests some possible near-term consolidation in terms of index performance, but still-strong performance looking ahead beyond six months.

In terms of possible consolidation near-term, the S&P 500 has gone nearly 18 months without a 2% daily decline. There have been periods in history with longer stretches of calm—including the longest ever between 2003 and 2007 and quite a few between the mid-1960s and mid-1980s. Still, by the time the streak reached this many days, the index in general started to sputter a bit (hat tip to our friends at SentimenTrader). All but two of the historical streaks at least as long as the latest saw the S&P 500 generally trade lower two or three months later. The exceptions were the "remarkable creeper trend" of 1995 and again in 2004 (during the aforementioned-longest streak in history).

As a result of the remarkable concentration of performance up the cap spectrum, the 10 largest stocks as a percentage of the S&P 500's overall market cap have surged to 38%, as shown below.

Extreme concentration

Source: Charles Schwab, Strategas, as of 6/20/2024.

Annual data from 1980-1990; monthly data from 1991-2024. Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. Past performance is no guarantee of future results.

There is often conflation of the largest stocks with the best-performing stocks. They are not one and the same. In fact, for all the focus on the so-called Magnificent 7 or the Fab5, among them, only Nvidia is on the top-10 list of year-to-date performers within the S&P 500. You might also be surprised that Nvidia is not the best-performing stock this year…that award (for now) goes to Super Micro Computer with its performance besting Nvidia's to the tune of more than 60 percentage points. As shown below, it also may surprise some that three of the top-10 best performers this year are not in the Technology sector, but instead in the Utilities sector. Credit the second-order beneficiaries of the artificial intelligence (AI) boom, as well as the build-out of the country's energy grid. The list has also gone "old school" with General Electric…go figure!

Source: Charles Schwab, Bloomberg, as of 6/21/2024.

All corporate names and market data shown above are for illustrative purposes only and are not a recommendation, offer to sell, or a solicitation of an offer to buy any security. Supporting documentation for any claims or statistical information is available upon request. Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. Past performance does not guarantee future results.

Air getting thinner

Looking ahead, we think a risk worth monitoring is the persistence of the aforementioned divergence between performance at the individual member and index levels. If we continue to see more weakness in the former and strength in the latter, it will start to eerily mimic 2021's dynamic. As shown below, as the S&P 500 has made several new highs this year, there has been a breakdown in the percentage of members trading above their 50-day moving average. That was the case in the second half of 2021 which, with the benefit of hindsight, correctly signaled that the market would no longer be able to hold up at the index level—thus leading to the bear market in 2022.

Moving higher with fewer

Source: Charles Schwab, Bloomberg, as of 6/21/2024.

Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. Past performance is no guarantee of future results.

A similar divergence has occurred within the Nasdaq 100, but as shown in the chart below, the index has had a stronger rebound lately in the percentage of members trading above their 50-day moving average. That likely speaks to the fact that in the post-pandemic world, investors have tended to jump into "big tech" when skittishness has crept in. Large-cap growth segments of the market have increasingly been treated as a form of defense.

Tech's rebound in participation?

Source: Charles Schwab, Bloomberg, as of 6/21/2024.

Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. Past performance is no guarantee of future results.

Even with that rebound, though, strength in performance remains concentrated in a handful of industries and names. As shown below, despite the fact that large-cap indexes like the S&P 500 and Nasdaq 100 have made several new all-time highs this year, that has not been the case at the individual member level. As of last Friday's close, fewer than 10% of members in both indexes were at new 52-week highs, with a steady deterioration over the past few months.

Source: Charles Schwab, Bloomberg, as of 6/21/2024.

Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. Past performance is no guarantee of future results.

Of course, it's not realistic to see every member at a new high at any one point, even in powerful bull markets. In fact, looking back to 2021, even as the indexes were soaring, there was never a day when more than half of members in the S&P 500 were at a new 52-week high; that kind of strength tends to happen in phases.

Given that, it's useful to also look at how many index members are falling to new lows—not just failing to make new highs. Shown below, as the year has progressed, there has been a steady climb in the percentage of stocks in the S&P 500 and Nasdaq 100 in their own bear markets (defined as being at least 20% below their 52-week high). They're not back to worrisome percentages seen during last year's correction, but the bar is arguably higher this time since the indexes have gone on to make new highs this year.

A small family of bears (for now)

In sum

This year's tale of two markets has been to the benefit of passive investors who are mostly focused on index-level returns. Major indexes have not experienced a correction, but under the surface, there have been declines of bear market magnitude. Of course, if there's a "good" way to go through a correction or a bear market, this year has probably been the epitome of that. However, we do see building risks of some consolidation at the index level if performance divergences persist into the second half of the year. While they don't seem imminently fatal to the bull market, we think more members will need to start joining the party for the music to stay on.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed. Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Past performance is no guarantee of future results and the opinions presented cannot be viewed as an indicator of future performance.

Investing involves risk including loss of principal.

The policy analysis provided by the Charles Schwab & Co., Inc., does not constitute and should not be interpreted as an endorsement of any political party.

Performance may be affected by risks associated with non-diversification, including investments in specific countries or sectors. Additional risks may also include, but are not limited to, investments in foreign securities, especially emerging markets, real estate investment trusts (REITs), fixed income, municipal securities including state specific municipal securities, small capitalization securities and commodities. Each individual investor should consider these risks carefully before investing in a particular security or strategy.

All corporate names and market data shown above are for illustrative purposes only and are not a recommendation, offer to sell, or a solicitation of an offer to buy any security. Supporting documentation for any claims or statistical information is available upon request.

Diversification strategies do not ensure a profit and do not protect against losses in declining markets.

Schwab does not recommend the use of technical analysis as a sole means of investment research.

Source: Bloomberg Index Services Limited. BLOOMBERG^® is a trademark and service mark of Bloomberg Finance L.P. and its affiliates (collectively "Bloomberg"). Bloomberg or Bloomberg's licensors own all proprietary rights in the Bloomberg Indices. Neither Bloomberg nor Bloomberg's licensors approves or endorses this material or guarantees the accuracy or completeness of any information herein, or makes any warranty, express or implied, as to the results to be obtained therefrom and, to the maximum extent allowed by law, neither shall have any liability or responsibility for injury or damages arising in connection therewith.

Indexes are unmanaged, do not incur management fees, costs, and expenses, and cannot be invested in directly. For additional information, please see schwab.com/indexdefinitions.

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About the Authors

Liz Ann Sonders, Managing Director, Chief Investment Strategist

Liz Ann Sonders has a range of investment strategy responsibilities, from market and economic analysis to investor education, all focused on the individual investor.

A keynote speaker at numerous company and industry conferences, Liz Ann is regularly quoted in financial publications including The Wall Street Journal, The New York Times, Barron's, and the Financial Times, and she appears as a regular guest on CNBC, Bloomberg, CNN, CBS News, Yahoo! Finance, and Fox Business News programs. Liz Ann has been named "Best Market Strategist" by Kiplinger's Personal Finance and one of SmartMoney magazine's "Power 30." Barron's has named her to its "100 Most Influential Women in Finance" every year since the list's inception, and Investment Advisor has included her on the "IA 25," its list of the 25 most important people in and around the financial advisory profession. Liz Ann has also been named to Forbes' 50 Over 50.

In 1999, Liz Ann joined U.S. Trust—which was acquired by Schwab in 2000—as a managing director and member of its Investment Policy Committee. Previously, Liz Ann was a managing director and senior portfolio manager at Avatar Associates, an original division of the Zweig/Avatar Group. She holds an MBA in Finance from the Gabelli School of Business at Fordham University and a B.A. in Economics and Political Science from the University of Delaware.

Kevin Gordon, Director, Senior Investment Strategist

Kevin Gordon serves as the research associate for Schwab's Chief Investment Strategist Liz Ann Sonders. In addition to providing analysis on the U.S. economy and stock market for Schwab's clients, he helps develop deep-dive projects as well as content for Schwab's public website, internal business partners, and social media outlets. Kevin is a frequent guest on CNBC, Yahoo! Finance, Bloomberg TV, and CBS News, and has been quoted in The New York Times, Forbes, MarketWatch, CNN, The Wall Street Journal, and Bloomberg.

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