Narrow Leadership Means More Pain for the Bears
They say that stocks climb a wall of worry. It’s true. Rarely is the march higher in equities a cakewalk.
The latest harbinger of equity doom is that weak breadth is a reason to be bearish. Those claims don’t hold water when you study the data.
Here’s the deal: Narrow leadership means more pain for the bears.
I’m sure you’ve heard this a lot.
“This market rally is way too narrow. A handful of overpriced tech behemoths are driving all the gains. Stocks are headed for a big drop as this shaky foundation inevitably crumbles.”
Sounds familiar right? So, are the bears onto something or just setting themselves up for more pain?
Today, I’ll debunk Wall Street’s latest favorite bearish narrative and show you how to position your portfolio to take advantage of it.
Narrow Leadership Means More Pain for the Bears
The bears are right that market leadership has been narrower than usual this year. Only 28% of S&P 500 stocks are outperforming the index vs. a long-term median of 48%.
So far, 2023 reveals the lowest constituent outperformance in 15 years:
But here’s what the bears miss. Narrow market leadership is good because it boosts forward returns. This actually makes sense given that a majority of stocks in the index likely represent value.
Consider the following.
Since 1928, the S&P 500 has posted 15.4% annual returns in the 12 months following periods of narrow market leadership vs. only 7.4% returns after very broad-based market rallies.
Said another way, narrow leadership means more pain for the bears:
You may be wondering why strong breadth tends to result in weaker forward performance? Ultimately, when everything’s already run up, it makes sense that future performance would be weaker as fewer names are left to power additional upside.
Today’s narrow leadership means there are still plenty of stocks with lots of room to play catch up.
Technology, communications and discretionary are the only sectors outperforming the S&P 500 YTD.
Financials, energy, materials, industrials, real estate, staples, health care and utilities still have plenty of upside, as do small and mid-cap stocks.
How to Play it
Fans of MAPsignals know we’ve loved tech and discretionary all year long. They’re still our two top ranked sectors. But market leadership is quietly starting to broaden out. Now’s the time to boost your exposure to lagging sectors as the rally starts lifting more boats.
Below ranks our sectors from top to bottom. Notably, all sectors are increasing in scores as breadth improves:
Additionally, our favorite indicator, the Big Money Index (BMI), also tells a different story than the media-driven weak breadth narrative. Healthy buying in select small-and-mid-caps has accelerated for months.
When the BMI rises, buying in stocks is healthy under the surface of the market:
So, what’s the play for investors?
The S&P 500 Equal Weight Index assigns all 500 index constituents the same weight. This dramatically cuts the influence of mega-cap tech while elevating the relative importance of everything else.
Technology, discretionary and communications total only 32% of the equal weight S&P 500 vs. 48% of the market cap weighted S&P 500.
Despite lagging the cap-weighted S&P badly YTD, the S&P 500 Equal Weight Index is outperforming slightly over the past month.
Invesco’s RSP ETF tracks the S&P 500 Equal Weight Index. It’s the best way to capture the large cap, “catch-up trade.” It has a low 0.2% expense ratio, a 1.9% dividend yield and a hefty $32B in AUM.
Below, you’ll see how the 1-month equal-weight index has dramatically turned course as internal leadership improves:
Wrapping up – the narrow leadership death nail is merely a tale when you study history. Add to it the recent breadth improvement, and you’re looking at a big bear trap ahead.
Bringing It All Together
Contrary to popular belief, history shows 2023’s narrow market leadership is bullish not bearish. Now’s the time to position your portfolio for broadening stock market leadership.
RSP is a great way to play the “catch up trade.”
Mega caps aren’t the only stocks worth buying as this rally broadens out. To outperform, use a map! Get started with a subscription here.
Invest well,
-Alec