Mid-Quarter Market Update

After weeks of negotiation and anxiety on Capitol Hill, the debt ceiling fight ended and with it, the threat of a US default. Following this resolution and strong employment news, major stock indices posted new 2023 highs.    

For some time, the October 2022 low seemed "the" low for this bear market cycle. Banks appear stabilized. Service sectors remain strong. Inflation continues its steady decline. Any recession in this cycle should be mild and has been "priced in" since October. However, one of the discomforting aspects of the market's advance this year has been its concentration in a handful of stocks. Leadership among the mega-cap technology and communication services sectors has strengthened and pulled the S&P 500 up 12% year-to-date. However, those same 500 stocks, on average, are up only 2%. Our discipline prevents us from holding concentrated risk that might equal the index. So, while lagging the index, our equities are well ahead of the averages to date.

To understand the calculus behind this phenomenon, we must explain how the index works. (If you already know this, please skip to the next paragraph.)  The S&P 500 is a market-cap-weighted index, meaning the larger the company, the more contribution to the index's returns. For example, Apple, the largest company in the world, has the most influence on the S&P 500 return. A good measure of what the average stock is doing is revealed by the equal-weighted S&P 500 index. Here each of the 500 stocks contributes equally to returns. As mentioned earlier, up only 2% year-to-date, the performance of the broader market looks quite different than the 12% index return. Similarly, only three of the eleven sectors that comprise the S&P 500 are up more than 2%.

A spread of 10% between the performance of the equal and market-cap weighted indices is the largest we have seen since the 2000s. They are generally in line with each other over time. The following chart displays another way to view this narrow advance in prices.



Over the past 60 days, just 12% of stocks have outperformed the S&P 500, the lowest reading in the 30 years shown above. We are not saying this is a precursor to another significant selloff, but it is likely a sign of some deterioration in the near term for mega-cap leaders. Typically, we can expect muted index returns after narrow leadership like this. Former price leaders pull back as gains spread more broadly. In other words, mean reversion is inevitable. Pinpointing this turn is an exercise in futility. However, while the indices may experience volatility in the near term, the rest of the market will catch up to the leaders. We are confident our focus on quality growth stocks will participate in this reversion.