Across 16 sector-specific ETFs, guess how many are making new all-time highs?
Two!
The S&P 500 (SPY), Nasdaq 100 (QQQ), and the Dow Jones 30 (DIA) hit new all-time highs this week.
Across the S&P Select Sector ETFs, only the technology ETF (XLK) and healthcare (XLV) managed the same.
How is this possible?
It comes down to market weighting.
Let me explain through another index.
The S&P 500 equal weight index (RSP) fixes all stocks to the same percentage of the portfolio at 0.2%.
In the SPY, Apple (AAPL) makes up 6.25% of the total index.
And guess what…
The RSP isn’t making new all-time highs.
It’s close.
But just not there.
This explains the frustration of traders and stock pickers these last few months.
The entire market is being driven higher off the back of just a few companies.
And that’s not healthy.
Consider common leading indicators such as the Dow Jones Transports (IYT), small cap stocks (IWM), and financials (XLF).
Each is 8.7%, 6.25%, and 6.3% from their all-time highs.
Want to hear something even nuttier?
The S&P biotech ETF XBI is down nearly 30% from its all-time highs putting it in a bear market (down more than 20%).
Even the gold ETF GLD is off more than 13% from its recent highs.
What conclusions can we draw from this?
First, these trends highlight the importance of always maintaining a portion of your portfolio in a general index fund.
This isn’t the first time we’ve seen markets rise on a few stocks and it won’t be the last.
Second, history tells us we can expect mean reversion. Or better said, either the major indexes fall down to the same level as the sectors or the sectors catch up to the major indexes.
Don’t expect this to happen overnight. Such a dramatic shift requires a fundamental catalyst that shifts the investor mindset.
Lastly, even though these types of divergences happen, they aren’t common. Typically, they appear at the end of an exhausted bull run.
That’s not to say the markets will go down. As stated in the mean reversion point, we could see a rotation out of the few stocks into a broader swath of equities.
Our hot take
When markets ride just a few stocks they become unhealthy.
Why?
Because your investments are no longer tied to overall economic expansion. They become company specific, effectively negating the point of diversification.
Questions from your clients
- Everyone says the market is going to crash. Is that true?
- How can I protect myself from extreme market moves?
- If I have money on the sidelines, what should I do with it since we’re near all-time highs?
- Are bonds safer than stocks?