Narrowing market breadth may be worrying signal for stocks

Investors are scrutinizing the stock market’s narrowing breadth and other signs of ebbing risk appetite, as markets digest a hawkish pivot from the Federal Reserve, soaring inflation and concern over a fresh wave of COVID-19 cases.

Only 31 per cent of stocks in the tech-heavy Nasdaq (.IXIC) are trading above their 200-day simple moving average despite the index’s 18 per cent year-to-date gain, according to Refinitiv data, the lowest level in at least a year. That number stands at 36 per cent for the small-cap-focused Russell 2000.

Stocks in the S&P 500 are faring better, with 68 per cent of constituents trading above that moving-average mark. Still, just five stocks – Apple (AAPL.O), Microsoft (MSFT.O), NVIDIA (NVDA.O), Tesla (TSLA.O) and Alphabet (GOOGL.O) - have accounted for about half of the index’s gain since April, data published by Goldman Sachs earlier this week showed. The S&P is up about 24 per cent for the year and stands near record highs.

Narrowing breadth can presage a period of rocky trading, with deeper-than-average drawdowns and weaker overall returns, Goldman’s data showed. The bank’s analysts said declines may be limited this time around by factors such as strong corporate earnings and a market that may have already priced in a more hawkish Fed.

Others are less sanguine. Tom Siomades, chief investment officer of AE Wealth Management, believes investors should brace for more market volatility.

“If you can’t live with that, you should definitely dial back a little bit of risk,” Siomades said.

The S&P is up 1.2 per cent and the Nasdaq is off 2.4 per cent this month, as the focus on an increasingly hawkish Fed has dried up risk appetite in some corners of the market.