Lack of market breadth – are recession fears apparent?

In our blog at the end of the first quarter of 2023, a current phenomenon in the stock market was already addressed: The (positive) performance of the US market in the first three months of the year was almost exclusively driven by the five largest individual stocks by market capitalization.

While the US equity market had gained more than 7% in the first quarter, the performance of the remaining stocks excluding the five largest stocks was just +1.4%. This development was accelerated not least by the massive increase in the valuation of NVIDIA’s shares in May: While the overall market was once again higher (+8.9%), the market would have fallen by -1.3% without the contribution of the five aforementioned positions. The market breadth has thus further decreased; the overall market development is exclusively supported by very few, large stocks with extreme price dynamics.

The concentration on a few stocks is also remarkable in a historical context. If we compare the market-capitalized performance with an equally weighted one, in which each individual company makes the same contribution regardless of its capitalization, the result is a difference of -10% over the period of the last three months. Never in the past 35 years has there been such a pronounced concentration on a small number of stocks. Even at the time of the dotcom crisis at the beginning of the 2000s, the number of companies increasing in value in the market was greater than at present.

Can this mistrust in the majority of listed companies be understood as a sign of an imminent recession? Historically, this correlation is not so easy to form. It is true that there were periods in past decades when both events occurred in sequence to each other. However, a lack of market breadth was not a clear indicator of a coming recession, nor did fears of recession lead investors to focus on a small number of supposedly crisis-resistant companies.

What can be stated with certainty, however, is that such a development always returns to normal and that this process is generally accompanied by higher volatility. Whether there is a recession or not, the coming months are likely to be more turbulent than the first half of the current year.