Despite its stumble to start the current trading week, the Nasdaq Composite (NASDAQINDEX: ^IXIC) is up 12% from the low point it reached near the end of last year, and it reached a four-month high on Friday. This is the best stretch we've seen from the index since 2021, before the recent bear market took shape.
If this is the shape of things to come, that bear market may well be ending.
Before jumping to such a conclusion though, be aware that the underlying support for this rally is extremely lopsided. Specifically, it's top-heavy. A trio of large caps (mega caps, actually) -- Tesla (TSLA 1.85%), Nvidia (NVDA 3.65%), and Facebook parent Meta Platforms (META 2.98%) -- are doing the vast majority of the heavy lifting. While you would typically expect to see powerhouse stocks resume their leadership of a struggling market when it's ready to recover, this isn't quite how you want to see it happen.
A poorly balanced rally
The aforementioned stocks haven't just had solid performances recently. They've catapulted. Meta's up by more than 22% since the end of last year. Nvidia shares rallied by nearly 32% in January. Tesla stock is up 36% year-to-date, and half of that gain materialized in just the past week. The rest of the Nasdaq Composite is struggling to keep up. It's these three stocks, in fact, that have largely pulled the composite out of its funk. No other mega caps even come close to beating the broad market in January.
And there's the rub. Most of the Nasdaq's other major names are bogging the rally down rather than boosting it. Not even Amazon (NASDAQ: AMZN) and Alphabet (NASDAQ: GOOGL) (NASDAQ: GOOG) are lending a helping hand -- even though they've made gains, they are lagging the Nasdaq Composite's recent performance.
That's not necessarily the end of the world. No two stocks ever dish out the exact same performances, after all. That's why the Nasdaq Composite exists in the first place -- it's meant to reflect the market-capitalization-weighted performance of all Nasdaq-listed stocks.
But that's also how and why the composite's recent strength could be misleading. Tesla's market cap alone accounts for roughly 3% of the Nasdaq Composite's total value. Nvidia's influence isn't far behind Tesla's. Meta Platforms makes up roughly 2.3% of the composite's total value. By themselves, these proportions aren't earth-shattering. Together, however, they make up more than 8% of the Nasdaq Composite's total market cap. Combine that degree of impact with the huge gains they've each recently achieved, and what you get are a heavily skewed index and a poorly balanced advance.
In simpler terms, were it not for Meta, Nvidia, and Tesla, the Nasdaq Composite's recent rally would not be anywhere near as impressive as it has been. The index might not even be toying with the prospect of exiting its bear market.
Perhaps worse, looking back just a bit further reveals that Meta, Tesla, and Nvidia were among last year's biggest Nasdaq-listed losers, leaving them ripe for exaggerated bounces now. Ditto for Alphabet and Amazon, albeit to a lesser degree. The composite's recent rally may mostly be the result of sheer volatility.
Proceed with caution
Don't misunderstand. A stock's recent history should have little to no bearing on an investor's decision to buy or sell it. The two most important questions any investor should ask before making a trade are (1) does this company have compelling long-term prospects, and (2) does this stock's price fairly reflect those prospects and the risks associated with them?
This isn't about a stock-picking approach, however. This is about understanding how market indexes work, and how they can sometimes paint a misleading picture. In this case, the Nasdaq Composite's rally may not be as well-grounded as it seems ... at least not yet.
It matters because stocks tend to move as a herd, with the majority of them taking their directional cues from the market's most-watched names. If Meta, Tesla, and Nvidia can't sustain their rallies, many other stocks are apt to follow suit with pullbacks of their own.
The good news is, there's still a chance this poorly balanced rally effort could become more balanced without pulling back and starting over first. We should give the market the benefit of the doubt and offer it a chance to do so before presuming the worst.
But, we should also proceed with caution here. There's no ironclad evidence the Nasdaq bear market is truly over yet. It won't be over until we see much more evenly balanced participation from the majority of Nasdaq-listed stocks.
