Conversely, the participation narrows to a smaller number of stocks when a bull market runs out of steam. Sort of a stock-market version of exhaustion.
In the 1960s and ’70s, a group of 50 large-cap stocks was so loved by investors that they were nicknamed the Nifty 50.
These were called “one decision” stocks.
However, it also included investment dogs like Xerox, Polaroid, Simplicity Patterns and S.S. Kresge.
Investors loved these stocks so much that they pushed the P/E of these Nifty 50 to a whopping 42 times earnings. At the same time, the broader S&P 500 was trading at 19 times.
In other words, the stock-market tide was still rising. But very few boats outside of the Nifty 50 were rising.
What happened next was the 1973-’74 market collapse that followed the Watergate scandal. This took down the Dow Jones by 45%. However, many of the Nifty 50 lost 70%, 80% … and even 90% of their value!
In retrospect, the narrow participation of the end of the great bull market of the 1960s and ’70s was a glaring, loud and clear warning sign …
Warning! That same type of narrow participation is happening today.
A good way to evaluate market breadth is by looking at the Guggenheim S&P 500 Equal Weight ETF (RSP). This Exchange-Traded Fund equal-weights each of the 500 components of the S&P 500.
To put that into a bit more perspective …
The S&P 500 Index is a cap-weighted index that places more weight on larger stocks like Apple, Microsoft, Amazon, Facebook and Alphabet (Google).
|Data source: Morningstar.com|
Cap-weighted averages — or proxies like the SPDR S&P 500 ETF (SPY) — can give investors a distorted view of the broader market’s health. Especially if it’s being unduly influenced by a relatively few number of stocks.
On the other hand, an equal-weighted index can give us a better sense of the level of participation across the entire index.
|Image credit: The Lyons Share|
As the accompanying chart shows, the Guggenheim S&P 500 Equal Weight ETF has been trending lower since early December.
In fact, this weak relative strength is a warning sign that has historically signaled trouble ahead.
Even as the stock market hit all-time highs in early June, the NYSE advance/decline line did not make an accompanying new high. On June 1, there were 339 new 52-week highs. But that number dropped to 223 the next day.
That’s just another way to say that while the FANG (Facebook, Apple, Netflix and Google) stocks are soaring, the rest of the stock market is failing to follow.
In other words, the current rising tide is not lifting all boats.
|Image credit: TheStreet.com|
Keep in mind that there are several ways to measure market breadth besides the equal-weighted S&P 500 and the NYSE Advance-Decline Line:
- Percentage of NYSE Stocks Closing Above 200-Day Moving Average
- Relative Performance of Small Caps (Russell 2000) vs. S&P 500
The share of NYSE stocks closing above their 200-day moving average has fallen from a nearby peak of 72% on Feb. 27 to below 60% in June.
Just remember, bull markets are the healthiest when they are broad … and weakest when they narrow to a handful of popular stocks.
If market breadth is any indication — and it has been in the past — the rising tide has hit … or is about to hit … the high-water mark.
The Guggenheim S&P 500 Equal Weight ETF (NYSE:RSP) was unchanged in premarket trading Thursday. Year-to-date, RSP has gained 7.40%, versus a 8.93% rise in the benchmark S&P 500 index during the same period.
This article is brought to you courtesy of Money And Markets.