Can the rest of the skeptics get back into the market? The S & P 500 finally broke out of its trading range on Friday, closing at 4,282, the high for the year and about 0.5% from its last 52-week high, which was 4,305 on August 16th of last year. You’d be forgiven for thinking the reasons were fundamental: a goldilocks jobs report (strong job growth but wage inflation moderating) and a debt ceiling deal, coupled with earnings that are not signaling an imminent recession. Wall Street seems to think a bit differently. In this world, most of the excess trading is due to “positioning,” that is, traders who are employing systematic strategies who go in and out of the market on a rules-based basis. One of the most widely-used strategies involves trading around volatility: when volatility is low, more money is usually in the market; when it is high, more money is out. On Friday, the CBOE Volatility Index (VIX) closed at 14.6, the lowest close in three years. That got those “systematic traders” all excited. “The positioning squeeze we expected has played out,” Binky Chadha from Deutsche Bank said in a note to clients Friday night. “Positioning is up from the bottom of its historical range to the middle or neutral, driven entirely by systematic strategies as vol fell, while discretionary investors have remained skeptical with their positioning range bound in firmly underweight territory,” he wrote. In plain English, whether the market can advance further may depend on whether it can drag in the rest of us who have been skeptical of the rally. “Further increases in positioning will not come easy, with systematics tied to vol already in normal ranges, while discretionary positioning is likely to rise only if and when growth prospects improve,” Chadha said. Market leadership is still narrow This year has proven a winner-take-all year. A small group of stocks account for most of the gains in the major indexes. The advance in those indexes, particularly the S & P 500, has been very uneven, even with last week’s broad rally. Not surprisingly, the chorus arguing that the tech rally is overdone has only gotten louder. “SPX returns attributable to its top 5 largest stocks are greater in 2023 so far than in any other year over most of the last decade,” Venu Krishna at Barclays wrote in a note to clients this morning. “The easy money has been made, and the pain trade/path of least resistance may no longer be to the upside.” The Wall Street Journal noted this morning that tech stocks have accumulated unusually high short positions. High short positions, of course, are contrarian indicators. Lowry Research analysts noted that investors simply in the S & P 500, or in tech stocks, were clearly in an up market. “But if they operate with a more diversified portfolio, the trend is actually down,” they wrote. In fact, a shockingly large number of stocks are in bear-market territory. Lowry noted that 48.2% of all operating-company only stocks are 20% or more below their 52-week highs, which Lowry and others define as bear market territory. That’s far worse than the 32% that were in bear market territory on February 2, when the S & P 500 was at a new high for the year. “Bull markets are hard-pressed to last when the number of stocks entering ‘bear market territory’ grows,” Lowry noted. Even large-cap stocks, which have been the big gainers this year, have seen a narrowing in leadership. Only 7% of large-cap stocks are within 2% of a 52-week high. That figure was 20% a month ago. “Diversified investors should not fall for the siren song of the indexes that are rising on the backs of just a few superstars,” Lowry said. Still, there’s reason to be hopeful the market advance may get broader. With the Fed set to pause, job growth still strong, inflation moderating, a debt ceiling deal behind us, and earnings for the second half still holding up, we may be at the start of a much larger rally. The rallies on Thursday and Friday “includes the Russell 2000 marching higher along with its large cap brethren with a fervor that has been missing since the banking crisis,” Quincy Krosby, chief global strategist for LPL Financial, said in a note to clients Friday. “The Russell 2000’s small-cap and mid-cap participation is especially important given its status as a bellwether for the broad economic backdrop.” Bottom line: it’s too early to say whether the rally is really broadening out. But early signs are encouraging.