Narrow rally hardly bearish

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It’s a poorly kept secret that the stock market’s year-to-date gains, as attractive as they may be, are due to an especially small number of companies. Through the first half of June, more than 90% of the S&P 500’s return has come from just seven stocks (Apple, Microsoft, Alphabet, Amazon, Nvidia, Tesla, and Meta).

Those are also the seven largest companies in the S&P 500 based on market capitalization. Together, they make up more than 27% of the benchmark. Put another way, they have an equal amount of influence on the S&P 500 as the bottom 392 companies combined.

There has been a lot of chatter in financial circles that the “narrowness” of this year-to-date rally suggests U.S. equities are more vulnerable to a correction. When these few shining stars inevitably fall back to Earth, the argument goes, the rest of the market will suffer the impact. It’s fair to say recent market strength has not been broad-based, but that does not necessarily portend weakness ahead.

Technology stocks, which have gained nearly 40% year-to-date, may appear overheated at first glance. But the NASDAQ is just 3% above the midway point between its all-time high and October 2022 low. The S&P 500, meanwhile, is 5% above its midway point. In that context, the aggressive rebound in tech stocks feels warranted.

More importantly, some forgotten corners of the market have begun to participate. Small-cap stocks, as measured by the Russell 2000, have outperformed the S&P in June after being flat in the first five months of the year.

The latest economic data also paint an optimistic picture. Although unemployment has ticked slightly higher from 50-year lows, job gains continue to be strong. Consumer spending has been robust. Inflation just fell to 4% year-over-year.

It’s also encouraging that equities have shrugged off the potential landmines created by regional bank failures and the U.S. government’s debt ceiling. Both presented an excuse to sell, but neither resulted in anything resembling a full-blown correction.

The conventional wisdom on Wall Street is that Big Tech outliers are not representative of the overall market. But what if those companies are simply ahead of the curve? We agree that more companies participating in a given rally is preferable, but who’s to say that won’t be the next chapter in the stock market’s recovery?

Even if the U.S. economy is headed toward a recession, the market tends to bottom six to nine months before economic growth does. That means the best buying opportunities often come before the recession hits. It’s entirely possible a shallow recession could trigger interest in stocks with more reasonable valuations and more modest year-to-date gains. A pivot, in that case, feels more appropriate than a sell-everything panic.

While the rapid adoption of artificial intelligence (AI) has provided justification to dump money into Big Tech, we would avoid investing more into the hottest performers. The performance gap between the S&P 500 and its equal-weighted equivalent in the first 5 ½ months of the year has never been greater, according to a Dow Jones Market Data analysis dating back to 1990.

This is an opportunity to invest in quality stocks that have not yet rebounded significantly this year. Take advantage of it.

Ben Marks is chief investment officer at Marks Group Wealth Management in Minnetonka. He can be reached at Brett Angel is a senior wealth adviser at the firm.