The stock market has always been a subject of fascination and speculation. Recently, we’ve witnessed an impressive surge in the S&P 500, which has raised questions about its sustainability. In the last 30 weeks, the S&P 500 has risen by +30%. By examining historical precedents and market internals, we can better understand whether this rally is a harbinger of continued growth or a precursor to a significant market peak.
The Unusual Nature of Recent Gains
A move of such magnitude and speed in the S&P 500 is rare. Over the past 40 years, such rapid climbs have only occurred six times. Some of these instances marked the beginning of extended bull markets, while others preceded dramatic declines, as seen in 1999 and 1987.
One striking feature of the 2024 market strength is its narrow base. Since March, the S&P 500 has climbed significantly, yet the average stock within the index has declined. This suggests that only a handful of stocks are driving the index higher, raising concerns about the rally’s sustainability.
A closer look reveals that the top seven stocks in the S&P 500 have returned an average of around 140% since the start of 2023. In stark contrast, the remaining 493 stocks have seen gains of less than 20%. This disparity further emphasizes the uneven nature of the current market rise.
Healthy vs. Unhealthy Rallies: Advance-Decline Line
To determine if today’s rally resembles those that led to further gains or significant peaks, we can examine past market behavior. Let’s start with the four rallies that resulted in continued growth: 2020, 2009, 1986, and 1982.
The Strong Rallies
2020: The market’s V-shaped recovery in 2020 was marked by a significant rise in the advance-decline line, indicating broad participation. Even before the market hit new highs, this line was climbing, suggesting that many stocks were contributing to the rally.
2009: Similarly, the 30% rally in 2009 saw the advance-decline line reach new highs, even though the market was still below its 2007 peak. This broad participation signaled a strong foundation for further gains.
1986 and 1982: Both rallies showed substantial increases in the advance-decline line, reflecting widespread stock participation. This broad base provided a solid foundation for continued market growth in the following years.
The Weak Rallies Leading to Peaks
Now, let’s examine the rallies that led to significant market peaks: 1999, 1987, and 1929.
1999: Despite strong market performance, the advance-decline line indicated more stocks were moving lower. This lack of participation weakened the rally’s foundation, leading to the 2000 peak and a subsequent bear market.
1987: A similar pattern emerged in 1987. The advance-decline line flattened while the market soared, indicating fewer stocks were participating. This set the stage for a dramatic 35% pullback, erasing that year’s gains.
1929: In 1929, the number of stocks participating in the rally declined as the market surged. This divergence signaled an impending peak, culminating in the historic market crash.
Current Advance-Decline Line
So, how does the 2024 rally compare? The advance-decline line made a new high in May 2024, suggesting broad participation earlier in the year. However, recent weaknesses have emerged, though they are not yet alarming.
Understanding the Impact of Leading Stocks
Headlines often highlight that a significant portion of the S&P 500’s 2024 performance is due to a few large-cap tech stocks like Nvidia. While these stocks push the index higher, the broader market is not showing the severe weakness seen in 1999, 1987, or 1929.
The RSP, an equal-weighted S&P 500 ETF, removes the outsized influence of large-cap stocks. Although it has underperformed the S&P 500 recently, its structure is not bearish. It broke through key resistance in early 2024 and is currently retesting important moving averages.
Strategic Portfolio Adjustments
In light of these dynamics, we recently closed our long positions in the technology sector and Indian stocks to rebalance our portfolio. We also increased our short exposure on a few stocks that we believe could face significant downside, even if the broader market continues to rise.
Conclusion
Understanding the nature of market rallies is crucial for making informed investment decisions. The current S&P 500 rally has been driven by a few key stocks. Historical patterns suggest that broad participation is key to sustaining gains. While the advance-decline line shows some strength, the concentration of gains raises questions. However, the equal-weighted S&P 500 ($RSP) is still in a bullish technical structure, indicating that the broader market is not weak as seen in 1999, 1987 and 1929. Click here to sign up! Subscribe to our YouTube channel and Follow us on Twitter for more updates!
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