This Stock Market Splash Has a Disturbing Undertow

The benchmark S&P 500 Index is wrapping up its second straight quarterly gain, rising 5.50% through Thursday and adding to the 7.08% surge in the final three months of 2022. This will be cheered as good news, confirming the stock market’s recovery from last year’s bear market and resiliency in the face of stubbornly high inflation, rising interest rates and bank failures. Don’t fall for it.

Underneath those topline numbers lurks a disturbing development — a very small percentage of stocks actually account for the rise. If not for a handful of highfliers such as Nvidia Corp., Meta Platforms Inc., Tesla Inc., Warner Bros Discovery Inc., and Advanced Micro Devices Inc., which all chalked up gains of between 50% and 87%, the S&P 500 would be struggling. In fact, when all stocks are weighted equally, the index is actually little changed, rising less than 0.5% for the quarter. Broader measures of the stock market, such as the New York Stock Exchange Composite Index, are essentially flat.

On Wall Street, this is known as bad breadth and a sign that despite the outward appearance of health, all is not well with the stock market. Longtime Wall Street watcher Ed Yardeni, who is credited with coining terms such as “bond vigilante” and “Fed model” highlighted the diverging performance between the S&P 500 and its equally weighted alternative in a note to clients this week. He pointed out that the ratio between the two tends to peak before recessions — making the recent January high a cause for worry. Other measures of breadth also signal weakness: the number of equities on the New York Stock Exchange trading above their 200-day moving average is lower that the average for the past decade; the same is true for the number of stocks hitting new 52-week highs less those touching 52-week lows.

To Yardeni’s point, it just so happens that Bloomberg’s latest monthly survey of economists puts the odds of a recession happening within one year at a lofty 65%, which is well above the average of about 25% going back to 2008. The same survey anticipates gross domestic product expanding at an anemic 1% in 2023. When you factor in the recent bank runs that led to the collapse of Silicon Valley Bank and the likelihood that the nation’s lenders will respond by tightening credit further, that 1% forecast may end up being generous.