Many investors check to see if the major stock indexes closed up or down for the day to form a quick opinion of the condition of the market and their own investments. The major indexes have characteristics which should be recognized to better understand the performance of the market. Indexes are a composite return of a group of stocks, but each individual stock is not weighted equally. For example, the S&P 500 Index is cap-weighted. Stocks with the largest capitalization have the heaviest weighting in the composite return of 500 companies. This results in a dozen or so of the largest companies in the country determining the performance of the S&P 500 index. Because the largest companies by capitalization are overwhelmingly in the technology and communications sectors, those two industries strongly influence the return of the S&P 500 Index.
A better understanding of what is going on in the market results from digging deeper and examining the performance of the eleven major industry sectors. For most of 2021 all eleven industry sectors were in a positive trend. A positive trend is achieved when a sector is trading above its 200-day moving average (rolling ten months). In the first half of 2022 ten industry sectors declined and traded in a negative trend. The only sector to stay in a positive trend in 2022 was energy. It had a volatile year, but it remained in a positive trend. This deterioration of most of the industry sectors resulted in the bear market of 2022.
A market recovery takes place when more and more individual stocks participate in the rally with higher prices. This is referred to as “market breadth.” A cap-weighted index return may mask what is really going on under the surface. A handful of large companies can pull an index up or down, but the real condition of the market depends upon how many individual stocks are going up or down. In the last half of 2022 market breadth continually improved. More stocks were trading at higher prices than those trading at lower prices. So even though the major indexes put in a new low in October, the number of individual stocks showing improvement grew. Market breadth continues to improve so far in 2023 with two-thirds of the stocks in the S&P 500 index trading in a positive trend at the end of January.
In the fourth quarter of 2022 about half of the industry sectors moved to a positive trend. A month later at the end of January all eleven major industry sectors are trading in a positive trend.
The technical improvement in the market over the last few months is notable and encouraging. The biggest challenge for investors appears to be an aggressive Federal Reserve monetary policy. The concern is if the Federal Reserve continues to raise short term interest rates, it may result in an economic recession in 2023.
Market breadth can change, so it is data we monitor regularly. Should fewer individual stocks trade at higher prices, that would be a signal that this rally which began last October may fail. As of this writing, the rally is intact and the outlook is encouraging. There is still plenty of pessimism about the economy and the geopolitical state of the world. We would expect to see increasing optimism as market conditions improve, too.
Written by Connie C. Guelich, CFP, AEP, CLU, ChFC. This represents our views at the time of this writing, and it is subject to change. It is not intended to be personal investment advice. If you would like to discuss your own account, please don’t hesitate to call us.