The big story of the market recently has been how a small group of big-cap technology stocks has substantially outperformed the vast majority of other stocks in the market. Since these big-cap names have a significant weighting in the indexes, they have created the deception that the market is much stronger than it really is.
There are a couple of reasons why the Fab Five have had so much influence. Names like Microsoft (MSFT) , Nvidia (NVDA) , Alphabet (GOOGL) , Amazon (AMZN) , and Apple (AAPL) are viewed as the best potential plays for the Artificial Intelligence (AI) theme. While AI will have a very broad impact, these big-cap names are seen as early leaders.
Another reason these big-cap names have been so strong is related to the AI theme - they are viewed as safe haven plays and have benefited from cash leaving banks and for folks looking for a place to park cash while the debt ceiling issue plays out. The AI theme provides a fundamental justification to go along with the view that these stocks are a safe haven in the storm.
This big-cap outperformance has been going on for most of the year, but there appears to be some slowing in the theme. There are more questions about the valuations of these stocks, which are selling at PEs about double their EPS growth and are unlikely to be able to continue that level of growth as the law of large numbers comes into play.
Back in 2021, there was a similar period where big-cap technology stocks outperformed while most of the rest of the market struggled. At that time, it was mainly driven by institutional money piling into stocks with the best relative strength and liquidity. It was driven mainly by momentum, and like most momentum, it continued longer than seemed reasonable.
When the big-caps finally rolled over in early 2022, the market recognized the fact that a bear market was already well underway in much of the market already.
Conditions are similar now, and it is important to monitor how this develops from here carefully. There is some toppy action, as most of these names are very technically extended. Also, if the debt ceiling issue is settled, then a source of liquidity for these stocks will be lost.
There have been some increased signs of rotation into small-caps recently, but it has been very choppy and has not persisted. On Tuesday morning, the Russell 2000 (IWM) outperformed, but that fizzled out due to worries about the debt ceiling.
One of the problems for the market is that when big-cap names start to struggle, it impacts the overall move and causes broad selling. However, in this case, it has been so narrow for so long that there are many good opportunities in secondary stocks, and they could find support much faster than the big-caps.
The market will continue to grapple with the debt ceiling issue on Wednesday but watch for some weakness in big-caps to gain traction. This market has been very narrow for quite a while, and that will eventually produce a reversion to the mean.