Will Bad Breadth Kill Your Portfolio?
My headline seems foreboding, but step away from the ledge. I’m not predicting an imminent stock market crash. Sure, the market as a whole is expensive and vulnerable to a pullback, but economic growth remains on track. Even better, the shares of many high-quality growth companies are still available at reasonable prices.
However, as this bull market gets long in the tooth, diversification becomes more important. You should hold a variety of stocks and bonds, large-, mid- and small-cap companies, as well as foreign and domestic names.
Risk mitigation also becomes more imperative. Below, I pinpoint an appealing hedge now. But first, let’s look at a worrisome market trend that requires vigilance.
The great divergence…
The S&P 500 hovers at slightly below its all-time high. But look closer. The majority of stocks in the index are down substantially. This “bad breadth” is a cause for concern and underscores the importance of maintaining a broadly diversified portfolio.
Bad breadth occurs when fewer and fewer stocks are participating in the upswing. It usually means that the major indices are at a peak, because a minority of companies are driving overall market performance. Equity breadth had been improving earlier this year, but now the divergence has reemerged.
As a market weighted index, the S&P 500 puts more weight on larger stocks. This method begets a winner’s bias because stocks that are moving up see their market caps increase. These rising stocks then gain more influence on the S&P 500’s performance.
According to recent data from Morgan Stanley (NYSE: MS), 56% of S&P 500 stocks are down by more than 10% from their recent highs. This compares to the S&P 500 as a whole, which is down by only about 2% from its peak. In other words, more than half of the S&P 500 is in correction territory.
The Silicon Valley Titans…
The rise of six Tech Titans has disproportionately lifted the S&P 500. Facebook (NSDQ: FB), Amazon (NSDQ: AMZN), Apple (NSDQ: AAPL), Netflix (NSDQ: NFLX), Alphabet (NSDQ: GOOGL), and Microsoft (NSDQ: MSFT) account for more than 25% of the market cap share of the S&P 500 (see chart).
Is the bull market about to snort its last gasp? Not necessarily. History shows that this divergence is not unusual. Since 1990 on average, 55% of the S&P was down more than 10% during periods when the index closed at new highs, and those stocks soon went on to climb higher.
Most analysts forecast that by the time the books are closed on 2021, the S&P 500 will have gained 20% to 25%. But along the way, we’ll probably experience a lot of choppiness.
That’s what we saw Tuesday, when the major U.S. stock market indices opened sharply in the green, following a positive inflation report, but then reversed direction and closed in the red. The Dow Jones Industrial Average fell 292.06 points (-0.84%), the S&P 500 declined 25.68 points (-0.57%), the tech-heavy NASDAQ fell 67.82 points (-0.45%), and the small-cap Russell 2000 declined 30.80 points (-1.37%).
Investors continue to worry about COVID Delta. Also on Tuesday, the yield on the benchmark 10-year U.S. Treasury note fell dramatically on the latest inflation data, dropping to 1.27% from 1.32%.
In pre-market futures contracts Wednesday, stocks were trading essentially flat. Investors are waiting to see key economic reports this week, including initial jobless claims and retail sales (Thursday), and consumer sentiment (Friday).
Your golden insurance policy…
Amid the conditions I’ve just described, there’s enormous potential this year and beyond for gold prices to rise relative to stocks. When markets get bumpy and uncertainty reigns, investors typically turn to the safe haven of the “yellow metal.”
Gold can provide both insurance and growth potential for your portfolio during crises. There are several ways to increase your exposure to gold, including gold miners, funds, or even physical bullion itself. Your choices depend on your investment profile and tolerance for risk. To learn more about hard asset investing, visit this link.