- The stock market isn’t performing quite as well as it appears if you strip out the market-cap weightings from the S&P 500 A small number of stocks doing a big portion of the lifting for an index can be problematic down the line A weaker-than-expected dollar is also helping bifurcate performance in the US stock market
As mega-cap tech goes, so goes the broader S&P 500.
The S&P 500 is weighted by market capitalization, meaning the most valuable companies in the index have the biggest influence. Apple, Microsoft, Facebook, and Amazon alone make up a whopping 10% of the index on a weighting basis, for example, despite accounting for less than 1% of the number of companies included.
With each of those four stocks up more than 16% year-to-date – and with three of them surging at least 31% – the S&P 500 has climbed by nearly 11% in 2017.
- Business Insider / Andy Kiersz, data from Bloomberg
But what happens if you strip out company weightings? Is the S&P 500 still a beacon of strength?
Not quite. The benchmark’s equal-weighted counterpart, which gives every constituent in the index the same weighting, has risen only 8.4% this year, lagging the regular S&P 500 by more than 2 percentage points. And the divergence between the two gauges has been accelerating, with the equal-opportunity S&P 500 having just completed its worst week of the year versus the market-cap-weighted version.
So what does it all mean? Put quite simply: The foundation of the US stock market isn’t as strong as it looks on paper. Less publicized industries are faltering under the surface as mega-cap juggernauts continue to impose their will on the overall direction of the market.
One big reason for this divergence is a weaker-than-expected US dollar. Down roughly 9% this year, the slumping greenback has helped the bottom line of multinational companies by making their exports more lucrative. And wouldn’t you know it, the conglomerates most enjoying that earnings tailwind are also the ones with the biggest index weightings.
Smaller, more domestically focused companies with weaker pull over stock indexes are failing to get a similar boost from the weakening currency. As such, the Russell 2000 of US small-cap companies has risen just 4.3% this year, less than half the increase of the S&P 500.
- Markets Insider`
There has also been some turmoil under the surface of the stock market on a sector basis. Energy stocks in the S&P 500 have slumped 14% this year as crude-oil prices have struggled to find footing. The resource slipped into a bear market in late June, throwing cold water on a sector that was just starting to pick itself up off the mat and expand profits.
Phone companies have also struggled, falling 9% in 2017. Frequently used as bond proxies because of their regular dividend payments and risk-averse profile, telecom stocks have come under pressure as the Federal Reserve has hiked interest rates, dampening the appeal of their yield.
To be sure, stock market breadth – a measure of how concentrated gains are – is not yet at levels that are low enough to truly be deemed worrisome. A Morgan Stanley equity-risk indicator that factors in breadth is still in neutral territory, supporting this notion.
Ultimately, narrow market leadership and flagging breadth are just two pieces to a much more complicated puzzle for stocks. Investors and strategists alike are increasingly flashing warning signs, but nothing has been drastic enough to truly spook traders. Yet.