It wasn’t that long ago — last summer, in fact — when analysts were wringing their hands over the narrowness of the stock market’s advance.
That was when the so-called FAAMNG stocks — Facebook Apple Amazon Microsoft Netflix and Google holding company Alphabet — were dominating the market and were largely responsible for keeping the bull market alive. They collectively represented more than 20% of the combined market capitalization of the S&P500 Index and many worried that the bull market would be in big trouble if any of them stumbled.
Stumble they did: Since early September, those six mega-cap stocks have lost an average of 8.7%, according to FactSet. And, yet, the bull market remains very much alive, with the S&P 500 higher today. What happened, and what does it mean for the stock market’s future?
That’s what I am discussing in this column, which will become a regular monthly feature. In it I will focus on an investment theme like this one that is receiving widespread attention from Wall Street research firms.
What “happened” is that the bull market transformed itself from one led by just a few big names into one of the most broad-based rallies in years. The research reports I read almost universally consider this transformation to be a sign of underlying stock market health and strength. They believe it means the bull market will continue for at least a number of months.
There are a number of different indicators that research analysts point to as evidence of the market’s newfound breadth:
Over what time period is this widespread breadth bullish? Martin said in an interview that, from his research, he found that past periods of similarly broad breadth led to “particular strength … in the 6-12 month time frame.” Over the shorter term, however, “market returns have been less reliable” especially when “froth extremes are present.”
Unfortunately, Martin says, now is one of those times of froth extremes.
I can confirm that froth is indeed present. Consider the average recommended equity exposure level among short-term stock market timers (as measured by the Hulbert Stock Newsletter Sentiment Index, or HSNSI). Three weeks ago, when I last reported in this space where the HSNSI stood, it was at the 45 percentile of the historical distribution since 2000. That meant that the market timers were slightly less bullish than their average over the last two decades.
What a difference a few weeks make. Now the HSNSI is at the 95 percentile of the historical distribution, well within the zone that contrarians consider to be extreme bullishness. Historically, the stock market has struggled over the one- to three-month horizon in the wake of bullishness this extreme.
Martin concludes therefore that “the market’s performance over the next few months is questionable” even as its intermediate-term outlook is favorable. What kind of scenario is consistent with this picture?
Martin says that a perfect recent example is the “January 2018 interim top, when excessive froth led to a nasty two-month correction in the 10%-15% range. After this sharp pullback, the market advance immediately resumed.”
