Stableford Capital Insights

Is Bad Breadth Unhealthy For Equities?

Equities were up a slight 0.2% in choppy trading during May.[caption id="attachment_4100" align="aligncenter" width="940"]

Exhibit 1—A Slight Move Up For Equities[/caption]The bigger story is the spread between the S&P 500 and the equal weighted S&P 500. As you likely know, the S&P 500 weights each constituent by market cap, with the most highly valued companies receiving the largest weights in the index. The performance spread between the S&P 500 compared to the equal weight S&P has been increasing since March and now stands at 10.3%.[caption id="attachment_4101" align="aligncenter" width="940"]

Exhibit 2—S&P 500 Market Cap Vs. Equal Weight: Bad Breadth[/caption]Most of the performance of the S&P 500 has been from 5 (large cap) stocks—indicating extremely narrow breadth. Long, sustained rallies generally are driven by wide breadth in the market, indicating healthy earnings across a wide swath of sectors. However, the equal weighted index is actually down for the year through May (i.e. all the performance is being driven by a few names). Performance is solely being driven by large cap tech, while other cyclical sectors are increasingly pointing to the possibility of a recession. If the current rally is to be sustained, equity breadth will need to broaden out—indicating better health across multiple sectors.[caption id="attachment_4102" align="aligncenter" width="940"]

Exhibit 3—Bond Yields Up Slightly During May; Yield Curve Remains Inverted[/caption]Meanwhile, during May, the 10 Yr. US Treasury yield increased 23 basis points to 3.64%. The yield curve remains inverted—a signal generally associated with recession. Note however, this signal is not infallible. Nor does it indicate the depth of a downturn. It is possible that we have a brief and mild recession that equities are able to look through.

Stableford’s View

How will equities resolve their bad breadth? This is a difficult call and much depends on timing. With current bearish institutional investor positioning it is likely that there is at least a short term move to the upside. The key to sustaining the move is improvement in the earnings outlook for cyclical sectors. Additionally, the Fed is hinting at further increases following a June pause. Furthermore, the Treasury is likely to issue over $1.1 trillion in debt over the next 7 months which could hoover all the excess liquidity that has been flowing into equities.

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