Market Breadth Has Collapsed

While marveling at the disproportionate performance burden shouldered by a handful of index heavyweights, BofA’s Michael Hartnett last week described the divergence within tech as “epic.”

Two-thirds of the Nasdaq’s YTD gain is attributable to just five stocks, he remarked.

This is a familiar refrain. In fact, laments about “concentration risk” are so ubiquitous as to be somewhat clichéd. Nevertheless, the ad nauseam character of the debate doesn’t mean the discussion isn’t worth having.

In his latest, Goldman’s David Kostin noted the rather astounding drop in the bank’s breadth index from the peaks in April to current levels. Specifically, the gauge maxed out earlier this year at the height of the reflation fervor before plunging all the way to just half of its historical average this month (figure below).

That’s ostensibly concerning, especially when you consider the weight of the world rests on the shoulders of high-growth names which, generally speaking, are vulnerable to a shift in the macro environment.

Kostin rolled out a series of familiar statistics which retain their capacity to “wow” despite the ubiquity of the “concentration risk” narrative.

Just five stocks accounted for more than half of the S&P’s return since the end of April, Kostin remarked, adding that MSFT, GOOGL, AAPL, NVDA and TSLA “together account for more than one third” of the benchmark’s 26% YTD return.

Those names have chipped in more than double their starting weight, Kostin went on to observe. Their combined share of index market cap is up 4ppt this year, to 22%.

Is that a risk? Well, yes. Obviously. And especially considering Tesla isn’t what one might call “reliable.” It’s prone to unpredictable swings and it’s also subject to “tweet risk,” not to mention being taken hostage by armies of retail investors harnessing the power of options dynamics to propel it into the stratosphere.

But more generally, history isn’t kind to stocks (relative to their average performance) following periods during which market breadth has deteriorated rapidly and significantly.

Over the past 40 years, Goldman found 11 instances of breadth deterioration comparable to the narrowing observed from April to October of this year. “Following most of these episodes, the S&P 500 generated a below average return over the subsequent 1, 3, 6, and 12 months,” Kostin remarked, adding that the benchmark “also experienced sharper peak-to-trough drawdowns in the months following these episodes.”

Of course, those type of “signals” aren’t infallible and, as discussed at length here, Goldman’s outlook for equities is generally constructive, all things considered and “fat and flat” projections aside.

The bigger picture takeaway is the same as it ever was and, as alluded to above, it really can’t be emphasized enough.

“Record index concentration is both a cause and a symptom of a narrow market,” Kostin said, on the way to noting that the market-cap weight of the 10 largest stocks in the index “has increased for each of the past seven years and now registers at 31%, the highest level since at least 1980.”