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In this month’s column, Shannon Lancaster, of Ravenscroft, looks at the risks of a narrow market and considers whether the situation may be changing.
After a volatile few months for investors, the S&P 500 is now nearly back to its all-time high but a quick look under the bonnet shows this year’s rising tide has not lifted all boats.
The S&P 500 is up around 20% in 2024, and the equally weighted version has returned around half of that. This is a result of decreasing market breadth (which describes how many stocks in an index are participating in a move in either direction) and indicates that a small number of stocks are moving the performance of an index.
The extremes in market concentration in the US are largely thanks to a select group of technology and communication services stocks known as the Magnificent Seven (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla), which has been driving the bull market. These companies make up around a third of the S&P 500 and have contributed significantly to top-line performance.
Is narrow market leadership an issue? While wider breadth generally indicates a healthier market rally, narrow leadership does not always indicate an imminent sell-off. Concentration of returns can serve as an indicator of frothy pricing but doesn’t help us with timing. Breadth can stay narrow and elevated pricing can persist, sometimes for far longer than seems logical.
While some are banking on this lopsided pattern continuing, many are concerned it will unwind. Anything that shakes the powerful hype around AI could cause contagion across the technology sector and with so much money flowing into passives, and many popular ETFs owning the same Magnificent Seven stocks, this could be painful for many investors.
Of course, it isn’t the first time concentration risk has been a concern. During the dotcom boom of 2000, the technology sector rose to 35% of the S&P before the bubble burst. Prior to the global financial crisis, financials made up a large proportion of the S&P and many investors believed this would continue indefinitely. The credit bubble burst in 2007, and the finance sector shrivelled, creating a more balanced diversified index in which healthcare, industrials, information technology and other business sectors had similar weights, reflecting the economy.
This quarter we have seen a slight change in performance patterns with the S&P Equal Weighted Index outperforming the S&P 500. This could mark the start of a more prolonged change in market leadership but without a crystal ball it’s impossible to know what happens next. Therefore, what can investors do? Regardless of whether the AI train loses steam, investing with bottom-up, active managers means that no matter what is happening in the markets, they should be ready to take advantage of market volatility and avoid the over-heated, frothy parts of any sector.
While businesses like Microsoft and Nvidia are likely to remain a key part of our lives, there are many beneficiaries of AI outside the technology sector and the US. There are therefore opportunities for investors to build resilient portfolios around structural trends and gain exposure to multiple sectors and regions that should perform well over the long term.
lFinancial promotion: The value of investments and the income derived from them may go down as well as up and you may not receive back all the money which you invested. Any information relating to past performance of an investment service is not a guide to future performance and may not be repeated.
