The US bear market seems to be receding into the past, with the stock market tacking on another 2% gain this past week. But the jury is still out as to whether a new bull market is truly underway.

The issue isn’t the extent of the market’s bounce. The Morningstar US Market Index is up 25.1% from its bear market low; for many investors, the standard for a bull market is a 20% gain from a low. The issue is that the market’s rally remains exceptionally narrow, led by a relatively small number of stocks.

“History shows that broad-based advances are more sustainable than narrow ones. By all accounts, this year has been a narrow advance,” says Jurrien Timmer, director of global macro at Fidelity Investments.

This is a topic covered in the last market update on our podcast Investing Compass.

One way to see just how limited the market’s gains have been is to shift the focus from traditional indexes to equal-weighted ones. The Morningstar US Market Index tracks companies incorporated and/or primarily listed in the U.S. market. Like most other popular market indexes, its weightings are based on the market capitalizations of those companies. The largest U.S. stocks make up the heaviest weightings in the index, while smaller companies have smaller positions.

The Morningstar US Target Market Exposure Equal Weighted Index is a collection of the 590 largest U.S. stocks, all of which are weighted equally. In 2023 through July 11, the US Market Index gained 16.6% while the equal-weighted index rose just 10.6%. A great majority of the difference comes from the outsize concentrations of seven of the very largest stocks in the US Market Index.

Performance

“The equal-weighted indexes show a different picture than the standard market-cap weighted ones,” Timmer says. “The equal-weighted index has been going sideways for a year, which is a long time.”

There have been some signs that this dynamic is changing in the last few weeks, Timmer notes. ”The latest month has pulled up the rest of the market a little bit, which is good news, but there’s still a very big dispersion.”

Concentrations Make a Big Impact on Overall Market Performance

Through the first half of 2023, nearly all the returns in the Morningstar US Market Index have come from the very largest stocks, including Apple AAPL, Microsoft MSFT, and Nvidia NVDA.

Apple—the largest technology company in the world by revenue and the largest stock in the United States by market cap—returned 45% through July 11. In the market index, Apple alone contributed 2.3 percentage points, or 14.3%, of the index’s total return of 16.6% for the period. In the equal-weighted index, though, the company only contributed 0.07 percentage points (less than 1%) of the index’s total return of 10.3%.

The contributions of the other leading stocks were almost entirely wiped away from the equal-weighted index as well. Microsoft (with a market cap of $2.6 trillion and a contribution of 11.5% of the market-cap weighted index return), Amazon.com AMZN (with a market cap of $1.4 trillion and a contribution of 6.5%), and Google parent company Alphabet GOOGL (with a market cap of $1.6 trillion and a contribution of 5.3%) each contributed less than 1% of the equal-weighted index’s total return.

Only Nvidia, which rose 190.2% through July 11, managed to contribute more than 2.0% (0.23 percentage points) to the equal-weighted index’s total return for the period. Meta Platforms META contributed 1.9% (0.2 percentage points) to the equal-weighted index, while Tesla TSLA contributed 1.4% (0.1 percentage points).

contribution

When Will the Market’s Concentration Broaden?

“My sense is that if earnings end up coming down more than the consensus expects, then these stocks will probably keep outperforming because they are considered a safe place to hide,” Timmer says.

On the other hand, he says that “if and when the Fed starts to signal that it is done raising interest rates, the market could really have some legs, and leadership could evolve to a much broader market than we’ve seen.”

If the current leadership of the few largest companies continues, “that’s a negative because it shows that investors don’t trust the rest of the market,” Timmer explains. “If the current leadership ends, I think that would be a good sign that we are in a new market.”
He continues: “My sense is that if earnings end up coming down more than the consensus expects, then these stocks will probably keep outperforming because they are considered a safe place to hide.”