We mentioned in our Q1 report that one of the “side effects” of long-term monetary and fiscal support provided by central banks over the last 20 years, has been to create a dependency amongst investors on perpetual stimulus. This, in and of itself, has led to an almost Panglossian belief that somehow, despite any evidence to the contrary, “all will be for the best in this best of all possible worlds”. An abundance of optimism, amongst a generation of investors that has never had to live with positive real rates of interest, together with higher disposable real incomes (see below), is a potent combination of force for markets to contend with.
Q2 has provided yet another example of this type of confirmation bias at work. Despite central banks in the US, EU, Canada, Australia and UK continuing to ratchet up hawkish rhetoric and with short-term interest rates heading inexorably higher, investors seem determined to focus all hope on one particular ray of light shining (in the shape of AI). They are seemingly willing to ignore all evidence of the dark storm clouds gathering on the horizon.
No one knows exactly who decided that the definition of a Bull Market should be taken to be a move higher of 20% or more in a particular Index or that, correspondingly, a Bear Market should be defined as a move of 20% or more lower by a particular Index. However, it seems reasonable to expect that bull or bear markets should be judged on a number of metrics including the breadth of their respective advances or declines as much as by the extent of the moves in either direction.
In that regard, the strong moves higher in both the Nasdaq and the S&P 500 so far this year have to be seen and judged in the context of the breadth of those moves as much as by the extent of the moves. A superficial examination showing the Nasdaq +30% YTD and the SPX +14% YTD would lead the casual observer to deduce that “all was well with Corporate America”. However, upon slightly more detailed analysis it quickly becomes clear that the moves higher in both Indices are based on the performance of only a very small number of stocks.
As the chart below shows, if we use the S&P500 Equal Weight Index (to reduce skewing effect of the mega-cap constituents) we see that whilst the Index itself is only marginally positive YTD, the majority of the broader index’s return comes from only seven stocks, which the media (and others) have been swift to name “The Magnificent Seven”. However impressive those individual returns may be, when viewed as part of the aggregate return generated by the Index itself is not something that could ever be called “broadly based”.
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