You don't have to look hard to find discouraging economic and market indicators. For example, the three-month/10-year U.S. Treasury yield curve is inverted the most in decades. This typically portends bad news for the economy.
But there's one stock market indicator that has never been worse. And here's what could be coming.
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Market breadth
J.P. Morgan recently cautioned its clients that market breadth is "the weakest ever" based on some measures. The firm's chief U.S. equity strategist, Dubravko Lakos-Bujas, warned that this could point to a "bearish outcome for the market."
Market breadth is a term used to describe how many stocks are participating in a move for a stock market index. There are several ways to measure market breadth. One common method is to count the number of stocks that are rising versus the number of stocks that are declining. JPMorgan analysts were particularly looking at the percentage of stocks in the S&P 500 that have outperformed the overall index in the latest rally.
Why is weak market breadth potentially bad news? It reflects that investors are only excited about a relatively small number of stocks rather than the broader market. In the past when this has been the case, economic downturns have often followed. In a truly healthy market, a high percentage of stocks will perform well instead of only a few.
The haves and the have-nots
There are two main reasons why the S&P 500's market breadth is so weak right now. First, a handful of big stocks make up a significant percentage of the total index value. Apple (AAPL -0.82%) and Microsoft (MSFT 0.22%) alone comprise close to 14.5% of the S&P's value. The top 10 companies in the S&P 500 make up nearly one-third of the index's total value.
Second, several of these mega-large-cap stocks have been big winners so far in 2023. Shares of Meta Platforms (META 0.11%) and Nvidia (NVDA 1.75%) have almost doubled year to date. Apple, Microsoft, Alphabet (GOOG 0.92%) (GOOGL 0.93%), Amazon (AMZN -0.09%), and Tesla (TSLA -2.44%) stocks are up more than 25%.
Indeed, the top 10 stocks in the S&P 500 have generated nearly 90% of the index's total return so far in 2023. That's an all-time record.
Meanwhile, 341 stocks that are in the S&P 500 have underperformed the overall index this year. Nearly half of the S&P's member stocks are in negative territory year to date. Well over 100 S&P 500 stocks are down by at least 10%.
We're seeing a market driven by the "haves" and the "have-nots." Many of the "haves" are surging due to investors' enthusiasm for AI. Many of the "have-nots" have fallen as a result of the banking crisis.
What should investors do?
If analysts are right that an economic downturn could be on the way, one pragmatic strategy for investors is to move their money into recession-proof stocks. These include consumer staples, healthcare, and utility stocks.
Perhaps the best approach is the one that Warren Buffett is taking to prepare for a recession. Build up a cash stockpile to take advantage of potential buying opportunities. Don't panic. And, above all, have a long-term outlook. What matters more than the breadth of the market is the length of time you're in the market.
