As Nvidia rises, concerns arise about deflated laggards in the stock market

The current state of the stock market in 2023 presents a dichotomy with a handful of mega-cap companies posting significant gains, which stands in stark contrast to broader market challenges and economic uncertainties.

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Kevin Gordon, senior investment strategist at Charles Schwab, emphasizes that the market story at the mega-cap level is primarily driven by momentum. Companies like Apple Inc. and Nvidia Corp. performed strongly, with Apple’s recent rally fueled by its ambitious ‘Apple Intelligence’ initiative and Nvidia’s strong performance in the artificial intelligence chip sector. These companies have not only strengthened their market valuations, but have also intensified competition for the title of most valuable company, often competing with other technology giants such as Microsoft Corp.

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Beneath the surface of these eye-catching gains, however, lies a less vivid reality for many other stocks. The S&P 500 and Nasdaq Composite indexes, which are heavily weighted by market cap, have risen impressively in 2023, gaining 13.9% year-to-date and reflecting the dominance of mega-cap stocks. In contrast, the equal-weighted version of the S&P 500, which treats all stocks equally regardless of size, has struggled, gaining just 4.4% this year. This disparity underlines the concentration of market gains in a few select stocks, distorting overall market performance figures.

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Adding to the complexity, the Dow Jones Industrial Average, a price-weighted index that reflects a more traditional industrial base, has lagged behind with a modest gain of 2.4% since the start of the year. This difference in performance measures raises concerns about market breadth (the number of stocks participating in market gains), which is crucial for sustainable market health. Nationwide’s Mark Hackett notes that despite record highs in the S&P 500, fewer than half of stocks are currently trading above their 50-day moving averages, indicating a lack of broad participation in the rally.

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Historically, such concentrated market rallies have often preceded periods of market correction or bearish sentiment, as we have seen in previous cycles. While this pattern does not guarantee a recurrence, it does serve as a warning sign for investors and market analysts alike. Gordon warns that a persistent gap between the performance of the mega-cap leaders and the performance of the broader market could indicate the market’s underlying fragility.

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Economic indicators also play an important role in shaping market sentiment. Despite robust employment data, recent revisions to first-quarter GDP growth have dampened economic optimism, pointing to possible “weakness” in the economic recovery. Signs of labor market normalization following the COVID-19 crisis further underline cautious economic sentiment, particularly affecting cyclical sectors such as energy and finance, which have seen recent declines.

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Looking ahead, Gordon suggests the market is facing a critical juncture. After transitioning from a phase of aggressive cost cutting, markets are now ready for a renewed focus on revenue growth. The sustainability of current market levels will depend on broader participation across all sectors and on sustained economic resilience. If market breadth continues to erode and economic conditions fail to support growth expectations, vulnerability to a market correction could increase.

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In summary, while mega-cap tech companies are driving the major indices to new highs, underlying market dynamics are revealing broader challenges and economic uncertainties. The combination of robust performance by a few giants and the battle for market breadth underlines the complexity and potential fragility of current market conditions, warranting a cautious approach from both investors and market participants.

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