The S&P 500 index peaked in late May 2015 at 2130, having enjoyed a seven year bull run. However, the current mix of strong dollar, weak oil and the peaking of the earnings cycle have pitched the US into bear market territory.

The dip into bear te rritory was preceded by a narrowing of market breadth. In local currency terms, the S&P 500 index returned -0.73% on a price basis in 2015 (and 1.4% on a total return basis) however, this number is skewed by a handful of large entities. In particular, the new darlings of the tech industry: Facebook, Amazon, Netflix, and Google (collectively termed as the ‘FANGs’), together with Microsoft and General Electric, produced outsized returns which dominated index performance. These six firms contributed in excess of 100% of the index level return, as shown in the table below:

Stock

2015 Performance

Contribution to Index Return

Netflix

134.4%

0.1%

Amazon.com

117.8%

0.8%

Alphabet (aka. Google)

45.3%

0.5%

Facebook

34.2%

0.3%

General Electric

27.5%

0.4%

Microsoft

22.7%

0.5%

Source: Bloomberg

Upon closer scrutiny, we would find that fewer than half of the underlying stocks made a positive return during the same period. Stripping out the distorting effect of the mega-caps, market performance was patchy at best:

Market Cap

2015 Performance (Average)

# of Companies

> $100bn

+8.6%

43

$50-100bn

+0.1%

49

$10-50bn

-0.2%

299

<$10bn

-16.1%

113

Source: Bloomberg, Standard & Poors

One of the indicators that better reveals this underlying trend is the equally-weighted S&P 500 index, where all stocks are treated equally, each representing 0.2% of the index. This index is not subject to the distorting large-cap dominance and the momentum effect resulting from assigning higher weights to better performing stocks. Presaging the August sell-off in 2015, the equally-weighted index decoupled briefly from the cap-weighted index, before underperforming the index since that to date and did not fully participate in the market recovery in Q4. While the cap-weighted index returned -0.7% for the year, the average stock was down -4%. The divergence between the two indices from peak to trough has widened to 3.4% as the equal-weight index lagged behind.

Market Breadth_1

Source: Bloomberg

Momentum indicators also confirm this. The percentage of stocks trading above their 200 day moving averages have plummeted by three quarters from roughly 60% at the peak to just 30% by the end of 2015, and even further to 17% today.  Even resilient stocks from last year have undergone a correction in January as market volatility spiked as a consequence of further oil price declines and China turmoil.

Market Breadth_2

Source: Bloomberg

This presents an eerie resemblance to the dot-com era, where preceding the peak of the TMT bubble, the equally-weighted index also underperformed the cap-weighted index, decoupling for an extended two years before the market crashed in June 2000, as shown in the chart below. The leaders of the period then were the likes of Microsoft, Cisco Systems, Pets.com, and Boo.com: again a handful of stocks pushed market indices to exuberant heights, while the rest of the market reflected more muted expectations.

Market Breadth_3

Source: Bloomberg

There have been several other occasions in history where a small group of stocks deviated away from the market; the Nifty Fifty in the 60s and 70s was also one of these times, as well as before the 2008 global financial crisis. We tend to associate the deterioration in breadth as a sign of market fatigue reflecting troubled fundamentals, as fewer stocks are burdened with the task of heavy-lifting the market, which is not sustainable in the long-term. As we write, major stock markets around the world have fallen in excess of 15% since their peaks around mid-2015, including the UK (-19%), Europe (-25%), Japan (-23%) and China (-45%), the worst of the batch. So far the US has only fallen 13%. Expectations, both towards economic growth and corporate earnings have further to fall in the US and we are outright short this market.

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