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U.S. equity market performance has begun to broaden out in recent weeks – an encouraging sign, to be sure. With the S&P 500 Index up more than 20% from its October low, how confident can we be in this new bull market?
While it’s true that a new bull market in stocks has technically begun – based on the rise in some U.S. indexes since last fall – it doesn’t mean the entire universe of equities is firing on all cylinders. To the contrary, the current rally has been one of the narrowest in recent memory, with just a handful of stocks making up most of the gains. At the end of June, for instance, 72% of the S&P 500’s total return year-to-date could be attributed to just six stocks, while 40% of the stocks in the index had a negative return over this period, according to Bloomberg data.
Moreover, the S&P 500 Index – which weights stocks based on market capitalization – was outperforming the S&P 500 Equal Weight Index by as much as 11% at the end of May. This represents the largest margin of outperformance between the two indexes since the turn of the century and reflects the fact that most of the high-performing stocks are also among the largest by market cap (and, therefore, make up more of the overall performance in the S&P 500 cap-weighted index than in its equal-weighted counterpart).
Granted, market performance has begun to broaden out in more recent weeks. And this is an encouraging sign. In fact, it may be a necessity if the current bull run is going to survive given how overbought many of the highest performing stocks are right now. Otherwise, where does the money flow when investors decide it’s time for them to take profits in some of these high-flyers? And even if that doesn’t happen, who is the marginal buyer of these few names going forward when they are already so broadly owned?
But here’s the potential rub: Markets are only likely to continue broadening for as long as investors feel comfortable about the economic backdrop and, perhaps even more importantly, the direction of monetary policy. After all, the reason why market performance narrowed so much this year isn’t just because many of the stocks that have outperformed are connected to the artificial intelligence theme, which is beginning to seem reminiscent of the dot.com craze of the late 1990s. They have also performed so well because they are well-known tech brands with strong growth characteristics and quality balance sheets that have come to represent safety for a lot of investors who did not feel the same way about many other parts of the market when central banks were raising rates aggressively or as bank failures spooked investors earlier this spring.
So, what’s changed? In part, the increase in market breadth in June seems to suggest a growing optimism about the U.S. Federal Reserve’s decision to pause its rate hiking cycle – at least for the time being. Even if the Fed ends up raising rates again later this year as it has said it will do, there is a consensus that the worst of the rate increases is behind markets and that rate cuts may not be too far off, albeit not likely until sometime next year.
At the same time, there is a burgeoning belief that a recession can be avoided despite months of speculation that it was inevitable. No doubt, this stems from the idea that rate hikes haven’t put much of a dent in key economic indicators like unemployment, but have been “doing the job” when it comes to reducing inflation, which has fallen by more than half since this time last year.
In other words, the idea of a “soft landing” is gaining credence with some investors despite there being no guarantee that such an outcome is in the cards. Remember, rate hikes affect the economy with a lag. And, because of that, it’s unlikely their negative effect on borrowing – and therefore economic activity – has been fully realized just yet – nor does it seem likely to us that a recession can be avoided once this effect finally does take hold.
Ultimately, the bull run in U.S. stock markets doesn’t quite jibe with the reality of the current environment and in some respect (i.e., its narrowness) seems almost like a mirage. That doesn’t mean it can’t continue, but it will surely take more than wishful thinking to keep it going.
Kevin McCreadie is Chief Executive Officer and Chief Investment Officer at AGF Management Ltd. He is a regular contributor to AGF Perspectives.
Notes and Disclaimer
© 2023 by AGF Ltd. This article first appeared in AGF Perspectives. Reprinted with permission.
Commentary and data sourced Bloomberg, Reuters and company reports unless otherwise noted. The commentaries contained herein are provided as a general source of information based on information available as of May 30, 2023, and should not be considered as investment advice or an offer or solicitations to buy and/or sell securities. Every effort has been made to ensure accuracy in these commentaries at the time of publication, however, accuracy cannot be guaranteed. Market conditions may change investment decisions arising from the use or reliance on the information contained herein. Investors are expected to obtain professional investment advice.
The views expressed in this blog are those of the author and do not necessarily represent the opinions of AGF, its subsidiaries or any of its affiliated companies, funds or investment strategies.
AGF Investments is a group of wholly owned subsidiaries of AGF Management Limited, a Canadian reporting issuer. The subsidiaries included in AGF Investments are AGF Investments Inc. (AGFI), AGF Investments America Inc. (AGFA), AGF Investments LLC (AGFUS) and AGF International Advisors Company Limited (AGFIA). AGFA and AGFUS are registered advisors in the U.S. AGFI is registered as a portfolio manager across Canadian securities commissions. AGFIA is regulated by the Central Bank of Ireland and registered with the Australian Securities & Investments Commission. The subsidiaries that form AGF Investments manage a variety of mandates comprised of equity, fixed income and balanced assets.
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