U.S. equities rally: A bad breadth problem

Quick takes on capital markets

June 23, 2023 | 2 min read

The S&P 500 has been climbing higher in recent weeks thanks almost entirely to surging mega-cap stocks that are riding the ripple effects of AI hysteria. However, with the rally driven by only a few companies across a narrow set of sectors, the broader market has a bad breadth problem. If these select few stocks fail to deliver on heightened earnings expectations, the broad market may be primed for a pullback.

S&P Technology sector price relative to S&P 500 price
1991–present

Line graph showing the S&P technology sector price relative to S&P price from 1991-2023

Source: S&P Dow Jones, Bloomberg, Principal Asset Management. Data as of June 22, 2023.

The S&P 500 has been on an impressive run, rising approximately 13% this year. However, the rally hasn’t been broad based. Instead, it has been driven by the explosive performance of only a handful of mega-cap stocks across the technology, consumer discretionary, and communications sectors—and all by companies firmly associated with artificial intelligence (AI) excitement.

The narrowness of this rally is undeniable:

  • Until mid-June, the five best-performing stocks in the S&P 500 had contributed 60% to S&P 500 returns this year (compared to an average positive contribution of 35% over the past decade.)
  • Additionally, the market-weighted S&P 500 is outperforming the equal-weighted S&P 500 by 11%—the largest year-to-date outperformance since records began in 1990.
  • Even more astounding, the outperformance of the S&P 500 Technology sector over the broader index is now higher than during the dot-com era.

Such narrow market concentration is a potential concern for investors, and against a backdrop of further monetary tightening and economic slowdown, a broadening of the rally looks challenging. From here, if the few stocks driving the rally fail to deliver on elevated earnings expectations, the broad market will likely be exposed to a pullback.

Despite solid equity performance, bad market breadth requires action in portfolios. Diversification via non-U.S. equities, which have lower tech concentration and thus are likely less correlated to the AI excitement, is warranted.

Disclosure

Investing involves risk, including possible loss of principal. Past performance is no guarantee of future results and should not be relied upon to make an investment decision.

The information presented has been derived from sources believed to be accurate; however, we do not independently verify or guarantee its accuracy or validity. Any reference to a specific investment or security does not constitute a recommendation to buy, sell, or hold such investment or security, and does not take account of any investor’s investment objectives or financial situation and should not be construed as specific investment advice, a recommendation, or be relied on in any way as a guarantee, promise, forecast or prediction of future events regarding an investment or the markets in general. The opinions and predictions expressed are subject to change without prior notice.

Principal Funds, Inc. is distributed by Principal Funds Distributor, Inc.

Securities are offered through Principal Securities, Inc., 800-547-7754, Member SIPC and/or independent broker/dealers.

Principal Asset Management leads global asset management at Principal.®

For Public Distribution in the U.S. For Institutional, Professional, Qualified and/or Wholesale Investor Use only in other permitted jurisdictions as defined by local laws and regulations.

© 2023, Principal Financial Services, Inc. Principal Asset ManagementSM is a trade name of Principal Global Investors, LLC. Principal®, Principal Financial Group®, Principal Asset Management, and Principal and the logomark design are registered trademarks and service marks of Principal Financial Services, Inc., a Principal Financial Group company, in various countries around the world and may be used only with the permission of Principal Financial Services, Inc.

2967325