We spoke to 3 experts who explained why the stock market's latest record is uniquely vulnerable to a sudden downturn
- The S&P 500 and Nasdaq both set record highs this week, but some experts say the market might not be as solid as it looks.
- Three Wall Street veterans who spoke to Business Insider note that only a small portion of S&P 500 companies are setting record highs of their own. They think the market's recent gains might be divided up among too few companies.
- The S&P 500's last record high was in September and the Nasdaq's came in August. The indexes suffered from the same lack of new highs then, and in the months following, stocks plunged almost 20%.
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Big stock indexes are setting records again, but experts say that if the market held a party right now, hardly anyone would show up.
This week the benchmark S&P 500 finally topped its previous record close from September, extending the bull market past the 10-year mark. The tech-heavy Nasdaq Composite reached a record high as well.
But when major indexes set records, stock market veterans use subtler measures to evaluate the market's strength. One way they do that is by seeing how many individual stocks on an index are setting 52-week highs or records. By that yardstick, the latest records don't look very impressive: 45 S&P stocks closed at highs Tuesday, or just 9% of the index.
There are a couple of reasons that concerns them. One is that a big chunk of the market's recent gains comes from just a few companies. That includes tech giants Microsoft, Apple, Amazon and Alphabet. They've all done far better than the broader stock market, which is up 24% from its low on Christmas Eve.
"It suggests there is less participation in the rally," Paul Hickey, the head portfolio manager for the wealth management business of Bespoke Investment Group, told Business Insider in an interview. "It's being driven by fewer stocks."
And that means that when some of those champion stocks start to struggle, it's more likely the broader market will also get derailed. If the gains were spread out between more companies, it would be easier for major indexes to keep rising even if a few big names were thrown off-course.
Another problem is that the last time stocks set records in this narrow way, the market ran into trouble almost immediately. Willie Delwiche, investment strategist for Robert W. Baird, says that in August and September, participation was just as narrow - and in the months after that, the index plunged almost 20%.
He said that if more than 70 S&P 500 stocks were making new highs on a given day, he would feel more optimistic about the state of the market.
"The number of stocks making new highs last summer remained relatively subdued," he said. "It becomes kind of a red flag."
In a recent note to clients, Hickey illustrated that point with these two charts. Compared to last summer and this week, when the S&P 500 was setting new highs at the beginning of 2018, a much bigger chunk of its component stocks were also making records.
This participation issue isn't limited to the S&P 500: John Lynch, chief investment strategist for LPL Financial, said it's "curious" that smaller companies aren't getting in on the rally either.
Indexes of small caps including the S&P 600 and the Russell 2000 are both down over the past two months, and weakness in those stocks can be a sign investors have growing concerns about the health of the US economy. If the economy slows, it's not going to help the stock market.
"We went to market weight the day after the Fed meeting" that ended on March 20, Lynch said.
None of the experts who spoke to Business Insider are predicting disaster right now even though they're doubting the market's strength. Delwiche said it's possible that the rally will get broader in the coming weeks, but he hasn't seen any evidence of that so far.
Lynch says his "worst case" would be a roughly 10% decline for the S&P 500, and he would find stocks more appealing after that kind of decline. He's maintaining a year-end target of 3,000 for the index.