The poor performance of most stocks recently has caused many on Wall Street to worry about the stock market’s outlook. Actually, it looks like a set-up for gains to come.
While
S&P 500
has gained about 12% for the year, the average stock hasn’t done much. Most of the index’s performance can be attributed to double digit-gains in Big Tech stocks, driven by a brightening earnings growth outlook because of artificial intelligence advancements.
But Big Tech is just part of the S&P, and the majority of stocks have not pulled their collective weight. The
Invesco S&P 500 Equal Weight
exchange-traded fund, which weights each stock in the index equally and therefore shows the movement of the average stock, has gained only 2% this year and is down from a recent peak hit in February.
That’s why people say the “breadth” of well-performing stocks is low.
That’s making Wall Street nervous. The thinking is that if Big Tech stocks falter — and recently they’ve taken a breather from their surges — the S&P 500 will also falter if other names don’t start picking up the slack.
Many economically-sensitive, or “cyclical” stocks, are well below their highs out of concern about lower profit from here as economic growth slows.
Morgan Stanley
strategists even say that the S&P 500 could drop to around 3,700 from just under 4,300 currently.
They are not alone. Poor breadth “reflects a market that is out of gear,” wrote John Kolovos, chief technical strategist at Macro Risk Advisors.
Being out of gear for the moment isn’t necessarily a death knell for the market, though. First off, Big Tech stocks could still be heading for long-term gains, even if they take a breather now. Analysts expect double-digit earnings per share annualized growth for the group for the next several years, except for
Apple
(ticker: AAPL), according to FactSet.
Secondly, other stocks, such as cyclicals, can rally. Once the Federal Reserve stops hiking interest rates, the economy should stabilize. That could send the price of commodities higher, a boon to oil and metals and mining stocks. Beaten down bank stocks could recover, too. Even defensive stocks, or those that benefit from stable profit regardless of the economy, could rise since they’ve already had a down 2023 after a strong 2022.
The point is that there are plenty of names to pick up the slack for the S&P 500 even if any one of these groups falters.
History proves the point. Recently, the majority of S&P 500 stocks have remained below their one-year highs, according to RBC. When that happens, dating back to 1990, the S&P 500 can often return double digits for the following 12 months. Sometimes, returns are negative for the coming year, but returns are positive when the market is sniffing out an economic recovery soon enough.
In early 2020, for example, the index swiftly plummeted, with most stocks getting crushed, but the following year brought about an explosive S&P 500 gain as the market had confidence that the pandemic-induced recession would quickly fade, with monetary and fiscal stimulus taking the economy higher as it reopened.
Today, markets are indeed expecting the economy to bottom soon. The residual impact of higher rates are still working through the economy, as seen by the fact that some still see a recession coming. But markets expect a stabilization to follow, so more stocks can join the rally, aiding index gains.
Right now, poor breadth is probably a positive sign, even if it feels scary.
Write to Jacob Sonenshine at [email protected]
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