The S&P 500 has rebounded to start the year gaining 9.6% in the first 5 months. Much of the return is concentrated in the top 10 largest components of the S&P 500 as the S&P 500 equal weight index
is negative over the same time period. Only 227 stocks in the S&P 500 are positive for the year with the median stock return of -1.85%.
Year-to-date market breadth has never been this low. The most recent similar events happened during the Covid market declines and in November 2008 during the financial crisis.
At the end of May, 40% of stocks were above their 200-day moving average and only 26% of the stocks in the S&P 500 are beating the overall index. Historically, when the number of stocks trading above their 200-day moving average are lower, future S&P 500 returns over the next year are below average.
The market-cap percentage of the five largest stocks (Apple, Microsoft, Alphabet, Amazon and Nvidia) in the S&P 500 index is near its highest reading in at least two decades, driven by the recent outperformance of mega-cap technology shares. The top five companies now make up 24.2% of the index by market cap, the highest reading since 2000. This is well above the 14.3% average witnessed in this time frame, and registers as nearly three standard deviations above the historical mean.
Investors Remain Cautious – Contrarian Indicator?
Generally, late business cycles sales hold up, but higher input costs reduce profit margins and earnings growth. Earnings held up in 2022, but current expectations for 2023 are for earnings to decline 2%. This is consistent with past late business cycles and much better than the average recession.
Looking past 2023 the market expects earnings to outpace the economy. Earnings typically recover stronger than they fall as downturns remove excess spending, resulting in thinner cost structures and improved margins. Cost reduction has been a theme over the past 2-3 quarters of earnings releases. S&P 500 earnings have declined in each of the previous 2 quarters (earnings recession) with an 8% decline expected for the second quarter with growth returning in the 3rd and 4th quarter.
Since the start of 2022, stock prices and earnings forecasts have been somewhere in the range between historical recession and non-recession bear markets.
The recession debate:
Large cap stock valuations spread over small and mid-cap stocks continues to widen. Finding the appropriate premium for margins, growth, and quality is key.
The valuation discounts relative to historical averages for small and mid-cap stocks provide opportunity. Mean reversion is highly probable.
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