Complaints about stock market's 'bad breadth' are overblown. Here's why.

By Joseph Adinolfi

Dramatic outperformance by a small group of the largest stocks distracts from fact that most stocks are still in a long-term uptrend, according to Ned Davis Research

Market gurus love to complain about the fact that the performance of indexes like the S&P 500 is increasingly being driven by a small cadre of megacap stocks.

But this carping about the market's "bad breadth" is missing an important point: While a handful of extremely valuable technology stocks like Nvidia Corp. (NVDA) have dramatically outperformed over the past year and contributed the bulk of gains at the index level, most U.S.-traded issues are still rising, according to Ed Clissold, chief U.S. strategist at Ned Davis Research.

"What the bears are perhaps missing is the difference between relative and absolute performance," Clissold said in a report shared with MarketWatch on Friday. "If megacap tech stocks were the only stocks rallying and the rest of the stocks were declining, then their concern would be legitimate. But that is not the case currently."

To wit, Ned Davis's "elite eight" basket - which includes Nvidia, Apple Inc. (AAPL), Tesla Inc. (TSLA), Alphabet Inc. (GOOGL), Microsoft Corp. (MSFT), Netflix Inc. (NFLX), Amazon.com Inc. (AMZN) and Meta Platforms Inc. (META) - has outperformed shares of the other 492 companies in the S&P 500 fivefold since the beginning of 2023, as the chart below shows.

But just because a handful of megacap names are soaring doesn't mean the rest of the market isn't also marching higher, albeit in less dramatic fashion.

Outside of the elite basket, most other stocks remain firmly in a long-term uptrend, with nearly 70% of the stocks in Ned Davis's multicap basket trading above their 200-day moving average.

By comparison, on the day the S&P 500 SPX peaked, the share of stocks in the large-cap index trading in a long-term uptrend was just 45%. And that number fell as low as 31.2% in February 2000.

In fact, it isn't uncommon for a handful of stocks to contribute an outsize share of gains for indexes like the S&P 500 and Nasdaq Composite COMP that assign a higher weighting to more valuable stocks.

"For cap-weighted benchmarks, it is common for a few stocks to account for most of the gains," Clissold said.

Clissold acknowledged that markets that are both narrow and concentrated can still be dangerous. Right now, the top 10 stocks in the S&P 500 account for nearly 34% of the index's market capitalization. That is just below the record high of 34.8% from Nov. 28, 2023.

"The ends of bull markets are often defined by a few stocks in uptrends and the rest in downtrends," he said.

Investors got a taste of the perils of heavily concentrated markets on Friday, when a sudden selloff in shares of Nvidia, the best-performing stock among the megacap names over the past year, helped drive the S&P 500 and Nasdaq into the red after both indexes had touched intraday records, according to FactSet data.

But this alone isn't reason enough for investors to be nervous. If anything, signs that investors are growing complacent are a greater cause for concern.

The NDR Crowd Sentiment Poll has been showing excessive optimism for 69 consecutive trading days, the sixth-longest stretch on record. The longer this exuberance persists, the greater the risk of a correction once sentiment finally retreats.

Bottom line: "It is okay for megacaps to lead if they are taking other stocks with them," Clissold said.

A team of analysts at Goldman Sachs Group (GS) recently came to a similar conclusion. After analyzing how extreme concentration affected returns over the past 100 years, they found that markets still managed to climb during the 12 months after concentration peaked.

See: Here's what 100 years of history shows about periods of extreme market concentration, according to Goldman Sachs

-Joseph Adinolfi

This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.

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03-08-24 1536ET

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