I want to talk to you about a crucial concept in the world of finance, market breadth.

You may have noticed that 2023 has been an incredible year for a select few big technology companies. The likes of Nvidia, Meta, and Tesla have seen their stock prices soar, with some doubling and even tripling in value. It’s been quite a ride, but there’s a catch. While these tech giants grab the headlines, they don’t represent the whole market. In fact, only about a quarter of the stocks in the S&P 500 index have outperformed it this year.

This raises an important question. Does the market’s lack of broader participation make it vulnerable to a downturn? To answer this question, we need to understand what market breadth is all about. Market breadth refers to the extent to which various stocks are contributing to the overall market performance. Think of it as the diffusion of performance across different sectors and individual stocks. Technical analysts believe that a rally with broad participation across the market is more meaningful and sustainable than a rally driven by just a few stocks.

At Advanced Wealth Management, we’ve evaluated the S&P 500 index based on sectors and individual holdings to see if market breadth can give us insights into the market’s future direction.

Here’s what we found: When only a few sectors outperform the index, or when too many sectors do, the market tends to deliver disappointing results. On the other hand, the best outcomes occur when four sectors outpace the index over a three-month period. And guess what? That’s exactly where we are today!

Now, let’s dig deeper. We also looked at the difference between two versions of the S&P 500 index, the capitalization-weighted index and the equal-weighted index. The capitalization-weighted index gives more weight to the largest companies, while the equal-weighted index treats every stock equally. Interestingly, the capitalization-weighted index has outperformed the equal-weighted index by a significant margin this year, indicating narrow breadth.

This phenomenon reminds us of two other periods in history: the beginning of the pandemic-induced lockdowns in 2020 and the tech bubble of 2000. In both cases, a small group of large companies led the market, but eventually, the average stock outperformed them. In the aftermath of the pandemic lows in March 2020, for example, the average stock surged more than 80%, outpacing the big names by a wide margin.

So, what does all this mean for you as an investor? Our study suggests that when the market becomes highly concentrated in a few stocks, it’s wise to consider alternative strategies. If you’re investing in US large-cap stocks, we recommend looking into an equal-weighted strategy or exploring US mid-cap stocks. History has shown that such moves tend to pay off over the next 12 months.

In conclusion, market breadth is a crucial factor to consider when assessing the health and potential returns of the stock market. It tells us whether a rally is supported by broad participation or is driven by a handful of companies. 

Remember, knowledge is power, and understanding market dynamics like breadth will set you on the path to financial success. Stay tuned for more insights and tips from Tony Gomes and Advanced Wealth Management. Happy investing!

DISCLOSURE-Please note that this commentary is intended solely for the purpose of providing general information. It should not be interpreted as advice on investments, taxes, or legal matters and does not establish an attorney-client relationship. The past performance of any market is not indicative of future results. While the information presented here is sourced from reliable outlets, it is not guaranteed.