Performance vs. Participation

"You know, Dan, there are only seven stocks holding the market up this year." I have heard some versions of this comment many times over the past six months. And with the S&P 500 on track to close the year up over 20% and the NASDAQ 100 on the verge of a ~50% year, the pitch is meant to be bearish. It is a riff on market breadth. The thought process is that the market is not healthy because only seven stocks account for a substantial portion of the performance mentioned above.

However, what these people miss is that performance (how much a stock is up or down) is different from participation (how many stocks are up in a bullish market and down in a bearish market). If most of the performance can be attributed to a small group of stocks, and those stocks happen to be the biggest in the market, then the market is going to move higher. This only becomes a problem IF the rest of the stocks in the market are not PARTICIPATING. That has not been the case this year, rendering the bearish case wrong.

Let's start with the seven stocks in question, the Magnificent 7:

1. Apple Inc. (AAPL)

2. Amazon.com Inc. (AMZN)

3. Alphabet Inc. (GOOGL)

4. Meta Platforms (META)

5. Microsoft Corp (MSFT)

6. Nvidia Corp (NVDA)

7. Tesla Inc. (TSLA)

You know them all well. Here is a chart that I created which displays an index of these seven market generals equally weighted.

What will jump out to most people is that this index is trading at new all-time highs. What jumps out at me is that this index has simply made up the ground that it lost last year. 

On a two-year basis, this index has not done much at all.

Do you remember what happened in 2022? There was a bearish trend for equities. The NASDAQ 100 lost ~40% of its value. The S&P 500 was under pressure for most of the year. 

Why? Because these names were under pressure for most of the year. It is the nature of a cap-weighted index to have its performance skewed by the largest stocks in the index. Put in the words of a good PR flack, "there is no story here."

Taking this a step further, we can see that relative to the S&P 500, the Magnificent 7 has not achieved a new high.

Now, the strategic buy-and-hold passive investor cares a lot about this dynamic simply because the index will usually live or die on the ebb and flow of the largest weights. However, there is not much this investor can do about it.

As a tactical manager, we care about performance, but when gauging the health of the market, we care more about participation.

If the market is strong, we expect to see a lot of stocks going up. In fact, if we were to keep a running total of daily net advances for stocks in the S&P 500, we might expect it to break to new highs ahead of the index. Time will tell.

If the market is strong, we would expect to see a lot more volume trading in the stocks that are going up vs. the stocks that are going down. Since November there have been seven days where volume in advancing stocks was more than 80% of the total.

Finally, if the market is strong, we expect to see a lot of stocks on the NYSE making new 52-week and six-month highs. On December 14th, both of these metrics set single-day records for 2023, and the 5-day moving average for each is also at yearly highs.

In conclusion, while the Magnificent 7 may be the stars of the show, the performance of a select few does not eclipse the broader participation in the market's positive trend.Market health is better measured by the breadth and depth of participation, and by these measures, the current bullish trend appears solid.

*All charts are from Optuma as of 12/12/2023

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