Narrow market rally poses risks

The S&P 500 has enjoyed its second consecutive quarterly gain, but the under-the-surface action suggests the rally is not as healthy as it might appear. Bespoke Investment last week noted that three of the S&P 500′s 11 sectors have made gains this year. The index’s biggest stocks, such as Apple and Microsoft, have soared, but their outsize weighting in market-cap weighted indices like the S&P 500 has masked broader market weakness.

Even the Nasdaq, which is up 15 per cent this year, is not as strong as one might think. The largest quintile of Nasdaq stocks is gaining, says market strategist Dan Greenhaus, but the other four quintiles have all been weak recently. Willie Delwiche of Hi Mount Research notes that one-third of Nasdaq stocks have actually fallen this year.

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Similarly, Kailash Concepts data shows that just 28 per cent of Nasdaq 100 stocks have outperformed the index this year. Ordinarily, it adds, around 55 per cent of Nasdaq stocks either equal or beat the index. Investors will be hoping the market rally broadens, rather than indices being dependent on a small number of large-cap stocks. “A narrow market”, says Ed Clissold of Ned Davis Research, “is a dangerous market”.