“Bad Breadth” Threatening Stocks Once Again

Stocks took a dip on Monday, cooling off from their recent hot streak. The reason? Fed Chairman Jerome Powell threw cold water on hopes for an early interest rate cut. He made it clear in a “60 Minutes” interview that the Fed isn’t in a rush to lower rates, emphasizing the risk of acting too early before inflation is under control.

This news made traders rethink their bets on rate cuts happening soon, affecting both the March and May outlooks, as seen in the CME FedWatch Tool. As a result, US bonds took a hit, pushing the 10-year Treasury yield up a notch to 4.08%.

With a slow economic news week ahead, all eyes are on corporate earnings for a spark. Last week, big wins from Meta and Amazon gave the market a much-needed lift. But Monday brought some disappointment with McDonald’s missing sales expectations.

The S&P 500, despite having more losing stocks than winning ones on Friday, closed on a high note. However, this mix of performances doesn’t usually spell good news for future returns, as per a 30-year study recently released by Bloomberg’s Akshay Chinchalkar.

A surprising jump in non-farm payrolls led investors to question the likelihood of rapid rate cuts. Yet, the tech giants came through once again, marking the fourth consecutive week of gains for the “Magnificent Seven,” which helped the broader market finish strong.

Despite these gains, the overall market breadth was negative, indicating a divide between Big Tech and the rest of the market sectors like banks, materials, and energy stocks. And, unless earnings growth picks up outside of tech, Big Tech will continue to dominate.

Historical data shows that when such a divergence in market breadth occurs, it often leads to a downturn in the S&P 500 in the following weeks.

January’s market breadth analysis also showed contraction, with the S&P 500’s equal-weighted index underperforming its standard non-weighted counterpart. Only a fraction of stocks outperformed the index, highlighting a lack of broad participation in the market’s gains.

The “Nifty Fifty,” a more focused group of the market’s top 50 stocks, outperformed the broader market, echoing the trend of earnings revisions this year. And while there’s no immediate sell signal, the weakening breadth indicators suggest that investors should take a more cautious outlook, especially in non-tech names that begrudgingly joined in on the rally of the last three months.

These stocks, unlike megacap tech names, don’t have the earnings to justify their recent rallies (and arguably big tech doesn’t either, but that’s a different conversation altogether).

Powell’s stance on rate cuts, expecting three in 2024 but ruling out an immediate move in March, adds another layer of uncertainty. As the market navigates these mixed signals, the name of the game will probably be how healthy breadth looks. The last time the market was anywhere close to breadth as “bad” as it is today was in late 2021, prior to the market’s year-long slide in 2022.

Does this imply that we’re going to experience another major correction? Maybe, maybe not. But the short-term danger to bulls is certainly building, especially for anyone holding non-tech names.


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