Market With Narrow Breadth Likely to Slump, Stovall Says

Narrow leadership in the stock market is bad for long-term gains, says CFRA Research’s Sam Stovall.

Right now, of course, the S&P 500 shows a small number of stocks at the top—mainly tech stocks—providing much of the locomotion. The index is up 8.1% this year, as of Wednesday’s close. Through the 2010s and up until 2022, the same handful of stocks, mainly tech ones, pulled the market with it.

This year, the biggest 20 mega-cap names have scored most of the gains. Through the first quarter, when the S&P 500 was up 7%, the remaining 480 stocks had advanced just 1% in 2023, per Apollo Global Management.

The largest five stocks—all of them tech, with Apple as the leader—make up 20% of the index’s market cap. Recall that Big Tech plunged last year when the Federal Reserve rapidly ballooned interest rates, and the segment sank the rest of the market: The S&P 500 lost 19.5% in 2022. This could be a precursor of what comes next for equities.

Never miss a story — sign up for CIO newsletters to stay up-to-date on the latest institutional investment industry news. 

Stovall’s measurement of market breadth is pretty standard: calculating whether the sub-industry categories in the S&P Composite 1500 index (that’s the large-cap S&P 500 plus the small-cap and mid-cap indexes) traded above or below their 10- and 40-week moving averages. When categories’ average are below that line, it signals narrow market breadth. Namely, the situation we have now.

This “indicator says (not guarantees) that broad participation was correlated with market advances, and vice versa,” Stovall, CFRA’s chief investment strategist, wrote in a research note.

By Stovall’s reckoning, since 1995, when the S&P 1500 was created, the 10 non-consecutive years with the widest-breadth market generated an average annual price gain of 20.2%. The 10 years with the narrowest breadth saw an average 6.2% price decline. For all 28 years, the average price rose 9.7%.

Stovall acknowledged that the theory of narrow-breadth markets’ seeming vulnerability has critics.

As he put it, “Skeptics of this concern point to: 1) the market being driven for years by the Nifty 50 in the late 1960s and early 1970s, 2) the length of time (two years) that a waning advance/decline line warned of an impending downturn (prior to the bear of 2000-2002), and 3) John Maynard Keynes’ warning that ‘Markets can remain irrational longer than you can remain solvent.’”