Katie Stockton on Weak Market Breadth Amid S&P 500 Highs and Russell 2000 Lows

Key Takeaway

• Market breadth has contracted despite the S&P 500 trading near all-time highs, indicating a narrow rally.
• The NYSE cumulative advance-decline line and Russell 2000 Index show signs of further short-term pullback.
• Despite current weakness, historical patterns suggest eventual breadth expansion supporting the cyclical bull trend in the S&P 500.

Narrow Market Breadth

The U.S. equity market has seen a contraction in breadth over the past few weeks, despite the S&P 500 trading near all-time highs. This contraction is evident in cumulative breadth metrics like the NYSE cumulative advance-decline line, which has pulled back since mid-May. The short-term momentum for the advance-decline line is currently to the downside, with room to next support from the daily cloud model. This suggests that market breadth will likely pull back further in the near term, posing a short-term risk for the major indices as the number of decliners outpaces advancers on the NYSE.

Weak breadth is also reflected in the ratio of the small-cap Russell 2000 Index to the S&P 500, which recently broke down to a new 52-week low. This breakdown marks a continuation of the primary downtrend in the ratio, indicating a setback for small caps relative to large caps. In absolute terms, the Russell 2000 has pulled back since mid-May, aligned with the advance-decline line. The major averages have been able to push higher recently, but there are signs that market breadth is deteriorating in a negative divergence. When there is a negative divergence between price and breadth metrics, it makes the market more sensitive to any ‘sell’ signals that arise.

Big Tech's Dominance

Big Tech continues to drive the S&P 500 rally, but the rest of the market needs to step up soon. The unceasing growth of Big Tech has been an article of faith for investors since the latest stock market rally began in October 2022. However, with an uninspiring earnings outlook for the rest of 2024, other sectors will likely need to contribute if share prices are to keep soaring. "To have a similar return for the market in the second half, you’d need to see broader participation," said Keith Lerner, co-chief investment officer and chief market strategist at Truist Advisory Services.

While Big Tech’s profit growth is expected to slow dramatically, industries like materials and health care are expected to see roughly 25% profit growth by the fourth quarter after posting contractions of 20% or more in the first quarter. This rotation already appears to be underway, with clients at Bank of America pulling almost $2.2 billion from tech stocks during the week ended May 31, the second-most in the bank’s data going back to 2008. The biggest client inflows went to the consumer discretionary sector, which is up 1.9% this year, making it the second worst performer in the S&P 500.

Fed's Role in Market Dynamics

A broad equity rally isn’t spilling over into the technology sector, where gains are still concentrated in just a few artificial intelligence winners that have become defensive plays amid an uncertain macroeconomic backdrop. An equal-weight version of the Nasdaq 100 Index has trailed its cap-weighted peer for seven consecutive weeks through Friday’s close, the longest streak of underperformance since the first week of February 2020. For the "equal weight, in general, to do better, we need to get a sense that the Fed is gonna cut rates," said Alec Young, chief investment strategist at Mapsignals.

Friday’s blowout jobs report threw cold water on hopes that the Federal Reserve will hand out multiple rate cuts this year. Following the print, Fed swaps no longer price in a cut before December. The S&P 500 Index and Nasdaq 100 initially dropped but pared losses to end the week higher by 1.3% and 2.5%, respectively. "There’s a lot of macro uncertainty right now. So it’s all about bottom-up earnings visibility. And the reality is that the mega cap, Magnificent Six really provide that," said Young.

Street Views

• Katie Stockton, Fairlead Strategies (Neutral on U.S. equity market breadth):

  "The contraction in breadth is evident in cumulative breadth metrics like the NYSE cumulative advance-decline line, which has pulled back since mid-May... This suggests that market breadth will likely pull back further in the near term, which is a short-term risk for the major indices as the number of decliners outpaces advancers on the NYSE."

• Katie Stockton with Will Tamplin, Fairlead Strategies (Cautiously Optimistic on cyclical bull trend in S&P 500):

  "Fortunately, while short-term breadth contraction is likely, a breakout in NYSE advance-decline line preceded the current pullback, suggesting that breadth should eventually expand in support of cyclical bull trend in the S&P 500. It is usually healthy to see periods of breath contraction during uptrends, as it can renew demand when markets appear extended."