Why narrow market breadth might not be as bad as it seems: Jonathan Levin

In 2024, critics have decried the US market's reliance on a few mega-cap stocks, known as the Magnificent Seven, arguing it signals trouble. However, recent shifts show these giants have dropped over 6%, while broader indices and small caps outperform. This development challenges the "breadth doom" narrative, suggesting that a narrow market might not be as harmful as feared. Despite volatility, investors in cap-weighted indices continue to see solid returns..Sign up for your early morning brew of the BizNews Insider to keep you up to speed with the content that matters. The newsletter will land in your inbox at 5:30am weekdays. Register here..Join us for BizNews' first investment-focused conference on Thursday, 12 September, in Hermanus, featuring top experts like Frans Cronje, Piet Viljoen, and more. Get insights on electricity and exploiting SA's gas bounty from new and familiar faces. Register here..By Jonathan Levin .___STEADY_PAYWALL___.For the better part of 2024, market commentators have bemoaned the fact that a few mega-capitalization stocks, dubbed the Magnificent Seven, appeared to be carrying the entire US market. To permabears, this "narrow breadth," as market practitioners call it, was proof positive that there was something wrong with the market, not their forecasting abilities. Fortunately, the Great Breadth Panic of 2024 seems to be ending in benign fashion, and the development may well provide some comfort to future generations of breadth doomers..Consider recent developments. Since the market started shifting on July 9, Bloomberg's Magnificent Seven index of Microsoft Corp., Apple Inc., Nvidia Corp., Amazon.com Inc., Meta Platforms Inc., Tesla Inc. and Alphabet Inc. has dropped more than 6%. The equal-weighted version of the S&P 500 Index has outperformed the cap-weighted version in that time, and small-capitalization stocks have done even better. That's great for the folks who have been betting on the Russell 2000, but they're still underperforming large caps by a wide margin since 2022..Read more: 🔒 US market's stock concentration – not all doom and gloom: McGeever.Is this a sign of a healthier market, as the breadth truthers would have us believe? Who knows? But the simple fact is that the typical investor holds the cap-weighted version of the S&P 500, which has basically moved sideways for eight days or so. The top equity exchange-traded funds by assets are all essentially a version of the vanilla float-adjusted, capitalization-weighted index. In a very obvious sense, life was better for most people two weeks ago when breadth was narrow..Breadth is just another fancy way that people try to outsmart the market, often in vain, and its recent prominence in the overall equity market narrative has proved far overdone as the past two weeks illustrate. To be sure, there have been some researchers over time who have found usefulness in breadth, including this 2021 paper in the journal Economic Modelling that reviewed 64 markets between 1973 and 2019. If you accept that investors tend to exhibit a herd mentality, the authors make the case that breadth can help detect which way the herd is moving. But importantly, the authors themselves also note that previous studies on breadth produced "mixed conclusions" about its usefulness, and they said that implementation of a successful breadth-based trading strategy "may encounter significant challenges," including high portfolio turnover and transaction costs..In the past decade, six stocks have accounted for 45% of the S&P 500's increase, and the index has outperformed its equal-weighted equivalent by 69 percentage points. The equal-weighted index has had its moments, but they've often been brief and hard to capitalize on. Whether or not that's a symptom of an "unhealthy market," whatever that might mean, is really beside the point. Investors who held the cap-weighted index did very well..A sports analogy seems appropriate here. It's nice to have five great players in the starting lineup of a team in the National Basketball Association, but that doesn't preclude a team from winning important games with just one superstar and a group of middling athletes in supporting roles. No doubt, it's a bit more risky to build a team around just one superstar, because he could get injured or have off nights. But those teams can, and have, won championships..In the stock market, the narrow breadth phenomenon isn't even as risky as it is in the NBA, because new companies are constantly joining the index, and laggards can quickly transform themselves into superstars. And in the long run, investors generally win..That doesn't mean that I think the recent improvements in market breadth, if they stick, are a bad thing. First, it's possible that this breadth recovery might prove short-lived, as was the case with a similar rebound from around mid-April to mid-May. Second, it might just not matter..Regular readers of this column know that I enjoy looking under the hood of market returns, and, occasionally, playing the parlor game of opining on its prospects. But you'd also know that I'm basically a "stay invested guy," echoing the gospel of Vanguard founder and index-investing icon John Bogle. I obviously don't know whether stocks will rise or fall in the short- or medium run. All I'm saying is that the astrologers and prophets who were so certain that bad breadth was an apocalyptic sign probably can't tell you either. Bear that in mind as they look for the next thing to worry about..Read also:.🔒 Powell's soothing reassurances are not enough to calm inflation-spooked US marketsSouth Africa could lose privileged access to US markets – Foreign Policy Analyst Peter FabriciusGoldman Sachs boosts S&P 500 target to 5,200 on surging profit outlook.© 2024 Bloomberg L.P.

Why narrow market breadth might not be as bad as it seems: Jonathan Levin

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