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In his latest post, Matthew Bartolini explains why it’s necessary to dissect equity performance through many lenses to reveal whether the narrow market narrative is noise or news.
With the S&P 500® up 21% off its March 24 lows and just 13% below its pre-crisis levels, a narrative is circulating that this is a narrow market rally, one where not all boats are lifted with the rising tide of stimulus actions and encouraging health news.
There have been clear winners and losers, as evidenced by sector dispersion that has surpassed Global Financial Crisis (GFC) levels and is now second only to dot-com era heights . However, that does not define the rally as narrow ─ or lacking breadth. It’s necessary to dissect equity performance through many lenses to reveal whether the narrow market narrative is noise or news.
Bad breadth?
Breadth (i.e., how many stocks are participating in a given move) is one way to measure a rally’s voraciousness. A simple measure of breadth is to examine an equal-weighted composition of stocks versus a market cap-weighted composition. Another measure is to compare different market cap ranges (e.g., small vs. large, mid vs. large). If the larger market cap-weighted exposure is the better performer, it can be reasonably understood that the market has weak ─ or bad ─ breadth.
All of this analysis is time dependent, as I am using two dates to capture these returns: the market bottom on 3/24/2020 through Memorial Day. And it must be appreciated that year-to-date, the S&P 500 market cap-weighted version has outpaced its equal-weighted version and traditional mid- and-small-cap exposures across the board, as its drawdown was not as severe. However, the question is not about the narrowness of the year-to-date gains, but rather the rally. And since the market bottom, the S&P 500 has been outpaced by all three, as shown below, with mid caps performing the most strongly.
Source: Bloomberg Finance L.P. as of 05/21/2020. Past performance is not a guarantee of future results. Figures shown are based on index data and do not assume any fees.
While this may signal that breadth is good, as equal weight is outperforming market cap weight, the differentials are small. And taking a deeper look, we see that over this time period, equal weight outperformed the market cap-weighted S&P 500 on just 45% of the days. It’s difficult to plant a flag on a broad versus narrow recovery with this data. More analysis is needed.
Perhaps the differences can be explained by sectors. To control for sector differences in this basic breadth study of market cap versus equal weight, I analyzed the return differences between a market cap-weighted sector exposure and an equal-weighted sector exposure. If not all boats are rising, then market cap should be outpacing equal weight. As shown below, that is not the case. Only six market cap-weighted sectors are outperforming an equal-weight version. Given that there are 11 sectors, that is roughly an even split. Now, there are some sectors where it is narrow at the top, such as Technology, Communication Services, and Consumer Discretionary. But the best-performing sector during this timeframe ─ Energy ─ saw an equal-weighted version outperform a cap-weighted version at the second-highest rate.
Source: Bloomberg Finance L.P. as of 05/21/2020. Past performance is not a guarantee of future results. Figures shown are based on index data and do not assume any fees.
Key takeaway: This basic capture of the market’s breadth didn’t answer this question, as the returns are too similar and lack noticeable consistent separation (percent of positive days) or trend among sectors. However, there are sectors that have exhibited a narrower rally than others have.
Top guns or bottom feeders?
Separating out the S&P 500 by deciles can add more insight. Now, the contribution to return of the top decile will be the largest, as those stocks have the largest weight. That is just math. Using that data point as a rallying cry for a narrow market rally is weak and reveals nothing other than an understanding of basic math. To understand performance trends by market cap, the average and median stock return by decile can be more insightful. As shown below, stocks in decile 1 (the largest market cap) have not had the best returns – both when calculated by taking the average and the median. The middle deciles had the best average returns, while the eighth decile had the strongest median return. The only consistency is that the 10th decile had the worst average and median.