2023 has been a challenging year for investors thus far due to conflicting data surrounding the health of the US economy. Many expected a new bull market following the simultaneous bear market in stocks and bonds in 2022. However, the data underlying the year-to-date stock market advance tells a different story.
Historically leading up to a bear market, the smallest companies (small cap stocks) turn down first as their businesses are the most sensitive to economic conditions. Conversely, the smallest companies also lead a new bull market for the same reason, these businesses are the most sensitive to changing economic conditions. While the Small Cap stocks led the stock market lower in 2021, they have yet to meaningfully rebound following 2022. In fact, small cap stocks have experienced negative returns year to date.
Caution flags are warranted when meaningful divergences occur between segments of the equity market such as lack of breadth or extreme concentration. In 2023, we have an extreme divergence of more than 13% between the S&P 500 and the Equal Weight S&P 500:
As well as noticeable divergences between the large cap stocks and every other market segment:
In addition, the concentration of the largest companies in the S&P 500 is more extreme than at any time since the dot com bubble.
While the 4th quarter is typically a strong period for performance, caution is warranted as one looks closely to the health of the broader US stock market. Such glaring imbalances do not historically bode well for future returns or the sustainability of the advance.
Data through 10/25/2023