2023’s US equity rally is narrow. That’s an understatement. And it’s not news.
Quite a few bear cases depend almost entirely on the notion that poor breadth makes for vulnerable markets, and that because this year’s tech-driven surge is among the narrowest rallies in living memory (at least on some key metrics), gains are unsustainable almost by definition.
There’s been some improvement recently, but not enough for bears. Not even close.
“Market commentators have been pointing out that the average stock is showing more life and even the worst performing areas this year like regional banks and small-caps are doing better as a sign that this year’s rally is broadening out,” Morgan Stanley’s Mike Wilson said. “We have been watching these areas too and while there may be some stabilization, it’s hardly impressive,” he added.
Wilson pointed to cumulative breadth in the Nasdaq, which he noted is “showing one of the widest divergences with price we have ever witnessed.”
If you ask Goldman, the more likely outcome is a catch up by laggards than a catch down by leaders, and while that may be cause for optimism, it’s not cause for complacency. Indeed, narrow markets generally mean drawdown risk is elevated.
A Goldman indicator which compares the index’s distance from its 52-week high to the same for the median stock shows breadth “has recently narrowed by the most since the Tech Bubble,” the bank’s Cormac Conners wrote, in a new note. The figure on the left below shows that collapse.
On the right, you can see how collapsing breadth tends to nod in the direction of larger drawdown risk.
Correlation isn’t causation, but as Conners went on to say, “following nine other episodes of sharply narrowing breadth since 1980, the S&P 500 typically traded sideways during subsequent months,” pointing to muted returns amid market churn. But the real worry is that “in addition to below-average returns, drawdowns have also been larger than average in these experiences.” Nearly three times as large on a six-month horizon in fact.
Take it for what it’s worth. Conners included that cautionary assessment in a list of reasons PMs may want to consider hedging the S&P 500.
