On the surface, one would think that the U.S. stock market is having a great year so far. After all, the S&P 500 was up 9.7% through May. A closer look tells a different story. The S&P 500 Equal Weight index in which all 500 stocks of the index receive an equal weighting was actually down 0.6% through May. The S&P 400 MidCap and S&P 600 SmallCap indexes tell a similar story with these down 0.3% and 2.0% respectively during this time. So why the discrepancy?

The S&P 500 is a market capitalization weighted index, meaning the largest companies in the index heavily drive performance. This can work in either direction, for better or for worse. Thus far this year, it has worked for the better as excitement surrounding artificial intelligence (AI) has driven a rally in technology stocks. The difference in performance between the S&P 500 and the market more broadly has reached an historic level. As stated in Barron’s on May 29th, “Not since 1999 has the disparity between the conventional, capitalization-weighted S&P 500 (dominated by the biggest half-dozen megacap techs) and the equal-weighted alternative measure of those 500 stocks been so egregious.” Many of us will recall that 1999 was right about the top of the Internet bubble that burst over the course of the next few years.

Further illustrating the frothiness of the S&P 500, a recent Ned Davis Research report showed that six of the largest companies in the S&P 500 (Apple, Microsoft, Alphabet (Google), Amazon, Meta (Facebook), and Netflix) now comprise a whopping 24% of the index value. However, these same stocks comprise just 16% of its earnings. According to Ned Davis Research this 8% gap is the widest margin on record.

While this segment of the market certainly seems to be very overextended, much of the rest of the equity markets afford better valuations and thus better long-term prospects in my view. June is off to a much more promising start for the broader market with the S&P 400 and 600 both up sharply, up 6.8% and 8.3% as of June 7th. It appears the script may be flipping on this tale of two markets.

Glenn S. Rank, CIMA®

Certified Investment Management Analyst®

President