In short, the breadth, or participation, is waning pretty dramatically. Basically, the rally isn’t nearly as strong as it appears. Let’s dive into some charts to illustrate what I mean by comparing the S&P 500 Index (Large Cap US stocks) to various sectors and asset classes. The S&P 500 is the blue line in all of the following charts, and all charts are set to align the last high-point to compare how much each has bounced back since.
How do Mid Caps look? Not bouncing back with the same vigor…
What about Small Cap? Ugh… even worse
So let’s look at some of the more economically sensitive sectors – Transports? Nope
Industrials? Forget about it
Materials? Horrible summer and not bouncing back anywhere close to the old highs
What about Retail? Those low gas prices are sure to be showing up as higher retail spending, right? No…
Surely healthcare, which has been booming the last few years, is driving this rally. Unfortunately not.
Then what is it??
The S&P 500 Index is market cap weighted which means the biggest companies have the most influence on the index. As we saw earlier, smaller stocks have been trailing. This next chart shows the S&P 500 Index compared to the Equal-Weighted S&P 500 (all 500 companies hold a 0.20% weighting to level the playing field between the big boys and smaller companies in the index). Notice how closely they usually track with the black line typically ahead of the blue line during rallies, indicating broad participation by companies of all size with extra strength by the smaller companies. This makes sense because the small/mid caps typically outperform when the economy is expanding. In financial jargon, we say they usually have a higher “beta.”
This is what I mean when I say that breadth is waning. This rally is being driven by only the largest of the mega cap stocks. Companies like Google, Amazon and Microsoft, which all jumped about 10% after announcing earnings, are creating the illusion of a stronger rally than is actually unfolding. You can also see how the equal-weighted index started to lead us lower back in July. It’s usually not a good sign to see a narrow rally with little participation which is why I still have a very cautious view on stocks.
If you’re curious, it has been technology that’s leading the way lately and is now sitting at new highs for the year. Consumer Discretionary has been strong too (i.e. Starbucks, Nike), despite retail in general looking weak.
In summary, I’d like to see broader participation across stocks before believing that the coast is clear for another leg higher. Fortunately for us though, we invest in individual stocks, not the index or “market” as a whole. And there are always nice opportunities popping up in specific companies.
A few weeks ago when stocks were nosediving, I bought stock in Paypal (PYPL) – the online and mobile payment processor. Last night they reported earnings and apparently they “missed” expectations. I was rather happy with what I heard so I was pretty glad to see Paypal open trading 5% lower this morning and used it as an opportunity to double down on the position. Paypal was spun-off from Ebay back in July to now operate on its own. I was very happy about that because this is one of the best combinations of strong growth at reasonable valuations that I’ve been able to find this year. Plus, there is a secular tailwind behind the company as the world continues to move toward online shopping and mobile payments that should lead to sustainable growth. This is one I’ll be adding to on any weakness.
Thanks for following!
-Nick
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