This stock market run may just be getting started...
Posted: July 28, 2023 18:05 PM
You’ve probably heard your favorite stock market guru make the claim that “The S&P 500’s gains are almost entirely from just 5 companies!” That hasn’t always been true, but due to the way that the indexes weight the underlying components, this phenomenon has gotten increasingly worse over the past decade. Check out this graph showing the relative performance of the largest 5 components of the S&P 500 versus the index itself for the period from Jan 1st of this year through the end of May.
So what does this fact actually mean? If these 5 companies hadn’t been pulling along the index, we would have had an even deeper decline in the S&P 500 than what was actually witnessed in 2022. The peak drawdown of the S&P 500 was just over 26%, bottoming in mid October, with the index posting a 19% loss for the full 2022 calendar year. Similarly, the tech benchmark QQQ ETF posted a 33% loss for 2022, but has since recovered for a 44% gain year to date in 2023.
While summer news headlines are beginning to pop up about the fantastic year the market is having in 2023, many investors are also wondering if they need to express extra caution as indices approach all-time high territory. How long can the “Big 5” stocks propel the market upwards? Could the laggard reporting of the effects rising interest rates cause stock earnings to miss and the market to plummet again soon?
The truth of the matter is, historically speaking, it’s a very good sign for the indices that we’ve had a good run without broad stock participation. In fact, if stock market breadth widens, the rate of acceleration of the 2023 market recovery is likely to increase!
The images here show the 5 year history of the Nasdaq New Highs-New Lows Index (NH-NL) and the Invesco QQQ ETF.
The NH-NL line represents the number of stocks that traded at the lowest price in the past 52 weeks subtracted from the number of stocks that traded at the highest price in the past 52 weeks. When you add that value to the total from the day prior, this line begins to paint a picture of whether or not the components of the overall index are generally going up or down.
During the 2019 bull run that took QQQ to all-time highs, the ETF rose over 65% in just over a year (60 weeks). When you look at the participation of the index components however, you can see that Nasdaq NH-NL was mostly flat, and only began to increase near the end of the time period.
Compare that to the period coming out of the COVID lows of March 2020. During this time frame the NH-NL index was increasing nearly every week. This resulted in a 95% gain to the QQQ in 67 weeks (and that does not even include the initial 25% gain that thrust the index out of the March bottom).
Now look at the corresponding declines of the QQQ and the NH-NL line for the entire period of 2022. The market sell off was accompanied by a steep drop off in the NH-NL line, where the majority of growth and tech stocks dropped over 50% and nearly half of those stocks declined over 80% from their peaks.
Finally, let’s turn our focus to 2023. In January and early February, the NH-NL chart posted a brief, 5 week increase. This same time period on the QQQ index saw a 20% gain to start off the year! The NH-NL line then dropped again while the QQQ digested those gains through the end of April. What has happened to the QQQ index since the last week of April? Another 25% increase in the past 3 months.
The QQQ index is nearing all-time high territory now, and many investors are worried about a dreaded ‘double-top’ on the indices that could send the market back down 30% again to the lows of October 2022. However, there is a good potential that that overall market may just now be starting to help along the ‘Big 5’. If that is in fact the case, another broad participation period could launch the overall market quickly past all time highs and into another year of record gains.
The market does appear to be slightly extended at this time, so it would make sense for some sideways trading to take place for the next several weeks until the fall. This would allow the moving averages time to catch up and assist the index with another leg up. Seasonality says that August and September tend to be poor months for the market in general, another sign pointing to potential stock market move this fall into year end.
The current market environment looks bullish overall. A pause near all-time highs would provide great fuel for a run higher in the intermediate future. A sharp decline doesn’t appear to be a high probability at this time, as leading and lagging indicators are still pointing up.
If you or a loved one are looking for some expertise in navigating your financial future, please feel free to reach out with any questions you may have. I’d be happy to get in contact with you.