The Market’s Bad Breath is Getting Better

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The market has been experiencing a case of bad breadth, but there are signs of improvement. However, it still remains a megacap world until proven otherwise.

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Turnaround for Stocks

In the past three weeks, the equal-weighted S&P 500 has seen a turnaround, with a 6% increase in value. This outperforms the market capitalization-weighted version of the index by three percentage points. So far this year, it has gained nearly 8%, although it is still only half of the regular S&P 500’s rise.

Dominance of Megacap Technology Companies

For much of the first half of the year, investors were focused on a narrow group of megacap technology companies due to factors such as regional banking turmoil, the artificial intelligence investing frenzy, and concerns over debt-ceiling negotiations in Washington. This led to the neglect of other stocks in the market. The seven largest U.S. stocks, including Apple (AAPL) and Nvidia (NVDA), have greatly outperformed the market, contributing to the rise of the S&P 500 while most other stocks in the index remained stagnant.

Shifting Sentiment and Economic Outlook

A market that is driven by only a few stocks cannot sustain itself for long. There is a shift in sentiment that is supporting the improving performance of a broader group of stocks. Recent data on the U.S. economy has shown strength, which bodes well for smaller companies that are more sensitive to domestic economic conditions. The pressure on the sector seems to be easing as the regional banking crisis subsides.

Small-cap Stocks and Banks

The small-cap S&P 600 index has a greater representation of banks compared to the large-cap S&P 500. As the regional banking crisis fades and the economic news improves, small-caps are benefiting. Ed Clissold, chief U.S. strategist at Ned Davis Research, states that the earnings yield of the S&P 600 is near a record high compared to the S&P 500.

In conclusion, while the market has shown signs of improvement, it is important to observe whether this trend continues and whether smaller companies can maintain their momentum in the megacap world.

Meme Stocks: A Risky Rally

The rise of meme stocks has reached a new level of risk and sentiment-driven trading. These stocks are typically associated with companies that have weak fundamentals and often high levels of short interest. Remarkably, Carvana (CVNA) has experienced a 29% increase in just one week, while Coinbase Global (COIN) has seen an impressive surge of 33%.

Meanwhile, the Roundhill MEME exchange-traded fund (MEME) has gained 13%, outperforming the Consumer Staples Select Sector SPDR ETF (XLP) by a large margin. The latter ETF includes stable companies such as Procter & Gamble (PG), PepsiCo (PEP), and Costco Wholesale (COST), which have only achieved a minimal gain of less than 1%.

According to Jonathan Krinsky, the chief market technician at BTIG, previous instances of meme stocks significantly outperforming consumer staples have resulted in near-term declines in the S&P 500. Krinsky points out that while it is encouraging to see a broadening of market breadth, such an extreme surge in meme stocks relative to defensive consumer staples typically indicates an unsustainable chase for speculative gains.

The market breadth could easily narrow once again, primarily if the economy stumbles or if inflation accelerates, leading to increased chances of further tightening by the Federal Reserve. In times of uncertainty and potential recession concerns, investors often seek refuge in megacap tech stocks and other stable businesses. It is worth noting that policy and economic risks may limit the tactical rotation away from large-cap stocks.

Only time will tell how long this trend will continue.

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