The S&P 500 has appreciated 25.2% year-to-date, through Friday, putting it on track for back-to-back years of 20%+ gains for only the fifth time since 1927. It has been the second time since 1955. The only other time was after the four-year streak from 1995-1998.
People have often complained that the market has been pulled higher by only a small number of large-cap companies, but this is the norm, not the exception. What makes this time different, as it is always a bit different, are the names of the leaders. This time it has been termed the Magnificent 7. What did seem truly remarkable this year was that only 28.2% of stocks have outperformed the S&P 500 year-to-date, putting it on track to beat the previous record low of 28.3% in 1998. The risk for anyone exposed to the U.S. stock market is that trouble from a few of the top stocks could drag down cap-weighted indices. Moreover, this is just exactly what we are experiencing. This final week of the year has started once again with a broad market drubbing.
Never before had fewer than 20% of NYSE issues advanced on any one of the last 3 sessions of the year. As can be seen below, going back 60 years, this is absolutely the worst!
I have been stating for the last few weeks that the market’s internal fortitude has been waning. When I say this, I am referring to the breadth of the market advance. Taking into account that the leaders have continued to pull the market up, I also focus on what the “other” companies are doing as well. This could be seen as a short-term warning message. There are two main reasons as I see it.
First, the Fed has begun cutting rates, but instead of being data dependent, as they normally are, they appear to be acting preemptively due to their expectations of extreme changes out of Washington later in January. Much like the market shockwaves that were endured in August when Japan changed its interest rate policies unexpectedly, our Fed has changed its direction of sight from backward to forward. On Friday, December 20th, the Wall Street Journal had an article titled, “Trump Is Already Spooking the Fed.” Besides tariffs, tax cuts and curbs on immigration are likely on the agenda once Trump takes office. These would to some extent be at cross-purposes with each other, some being stimulative while others would tend to hold back growth. But all three would likely have the impact of pushing prices higher.
Second, even though investors tend to be quite optimistic about what the Trump administration will mean for markets, the equity markets are a discounting mechanism, and the gains have already partially been built in. This sets things up for a perfect reason for year-end profit taking. This makes me take a pause in my investment selection, but I tend to not put much emphasis on what is moving in these last few days of the year.
Not to dismiss these very real risks of short-term market decline and breadth deterioration, but from a technical analysis perspective, the more pertinent question is not if the biggest stocks are continuing their upward ascent, but if other stocks are participating in like fashion. Put another way, it is okay for the generals to lead, as long as the infantry follows.
What to watch: The better question right now is whether the move in indices is being confirmed by breadth indicators. The dominance of mega-caps is not a problem in and of itself if most stocks are participating. That has been the case for much of the bull market that started in October 2022, but recent lower breadth readings suggest the infantry is at risk of deserting the generals. In last weekend’s Barrons, they called upon the sage, Felix Zulauf for his opinion. According to him, he feels that the market’s advance should continue. He cautions Barrons about overwhelmingly positive investor sentiment, and broadening declines in the laggards at year end, but feels that the massive liquidity still present should provide a backstop of purchasing power to keep the advance afloat.
The last thing that I ask myself is if there is anything else, big enough to have an effect, that has not been accounted for in the market trajectory. The last thing that I feel has not been measured to the extent that it should is the productivity boom that is still in store for the US economy and subsequently equity markets in 2025. Ed Yardeni of Yardeni Research feels that an AI productivity boom could be the next wave of the “Roaring ’20s.” That might sound delusional to some, but the past productivity booms in the late 1950s (interstate highway buildouts), the 60’s (mainframe computers and jet engines), and the 1990s (personal computers and the internet), all peaked the markets, and this AI boom is expected to be the boom of all booms.
Wishing everyone a healthy and happy New Year!
- Ken South, Newport Beach Financial Advisor
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