‘Narrow Market Breadth’ Could Kill the Stock Market Rally

July 23, 2020 4:00 PM UTC
Over-reliance on a small handful of technology stocks could erode the S&P 500's impressive relief rally since March.
  • The S&P 500 Index is up 1.4% this year, but without the top-five stocks, it’s down 5%.
  • Alphabet, Amazon, Apple, Facebook, and Microsoft has returned 35% in 2020.
  • New data suggest jobless claims are accelerating again as the United States struggles to contain Covid-19.

Wall Street’s over-reliance on a handful of technology stocks could be the most significant risk facing the market, analysts say. Fears that the post-pandemic recovery is losing steam could be the pin that pops the 2020 bull market rally.

S&P 500’s Heavy Concentration Becoming Problematic

A small handful of advancing stocks has driven the U.S. stock market’s impressive rebound since March.

Alphabet (NASDAQ:GOOGL), Amazon (NASDAQ:AMZN), Apple (NASDAQ:AAPL), Facebook (NASDAQ:FB), and Microsoft (NASDAQ:MSFT) have returned 35% in 2020, according to Goldman Sachs. The remaining 495 S&P 500 constituents are down 5%.

Mega-cap technology stocks are not only overvalued, they risk overwhelming the market rally in the event of large drawdowns.

David Kostin, Goldman’s chief U.S. equity strategist, says:

Narrow market breadth has often preceded large drawdowns in the past.

These five stocks have pushed the tech sector’s valuation premium to the highest in 20 years.

Narrow market breadth is a problem because it exposes the S&P 500 to significant losses if any one of these companies drops significantly.

Kostin says:

For example, if the FAAMG stocks declined by 10%, in order to keep the market trading flat the bottom 100 S&P 500 stocks would have to rise by a collective 90%.

The S&P 500’s concentration goes far beyond the mega-cap technology stocks. A single company accounts for 10% or more of the market cap in nine of 11 S&P 500 sectors. Communication services–the index’s newest category–has the highest concentration, followed by energy and information technology.

Most S&P 500 sectors are driven by one or a handful of companies. | Source: Fidelity

Other Imminent Risks

Tech-sector concentration is one of several risks facing the market in the short term. An upsurge in Covid-19 cases, ballooning deficits, and worsening U.S.-China relations are all impediments to the stock market.

Now, there’s evidence that the economic recovery is losing steam in the segment that matters most: employment.

Initial jobless claims, which measure the number of Americans filing for first-time unemployment benefits, reaccelerated last week.

Claims rose by 1.416 million for the week ending July 18, the Department of Labor reported Thursday. The figure was notably worse than expected and the first time in four months that claims rose from the week before.

Jobless claims reaccelerate for the first time in 16 weeks. | Source: ZeroHedge

The U.S. economy hasn’t followed the stock market’s V-shaped recovery, and another wave of lockdowns makes a double-dip recession more likely.

A continuation of lockdown measures likely won’t hurt technology companies in the near term. The sector continues to grow amid the pandemic, with Microsoft being the latest to report better than expected earnings and revenues for the second quarter.

Big tech’s continued growth during the pandemic could accelerate its market takeover, making the ‘narrow market breadth’ problem all the more acute.

Josiah Wilmoth edited this article for CCN.com. If you see a breach of our Code of Ethics or find a factual, spelling, or grammar error, please contact us.

Last modified: July 23, 2020 3:02 PM UTC

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