So far this year, overall market action has been distorted more by a small group of large stocks than ever before. Historically, the top-five stocks by market capitalization in the S&P 500 make up about 10-13% of the indices, but this has nearly doubled in 2020 and created a false impression of what is going on with the great majority of stocks in the market.
There are several reasons why this concentration has occurred, but in recent weeks it has started to reverse. The Nasdaq 100 (QQQ) has dropped around 10% and is still in danger of falling through support at the 50-day simple moving average.
If you are simply looking at the major indices, you are primarily looking at the FATMAAN stocks, and your impression of the overall market is likely distorted. What complicates this matter is that these are "leadership" stocks and the overall market action is largely correlated with their movement. The trillion-dollar question is whether the broader market can decouple from the super-cap stocks and produce positive action.
Based on some of the recent action, the answer to that question is yes. It is possible for money to rotate out of the FATMAAN names and into other sectors that are not as extended technically or fundamentally. On Monday, we saw a very good example of this as the Biotechnology Index Fund ETF (IBB) jumped 5.4% in large part due to merger activity.
While the biotechnology group had topped on July 20 and has been correcting for a while, that action was hidden by the continued strength in the FATMAAN names. What we saw Monday was some reversal of the flow.
It isn't just biotechnology that is seeing some benefits from money coming out of FATMAAN names. Financials and certain value names perked up Monday and there has been strong momentum in the EV and SPAC sectors.
What is most notable about the market action right now is that it is not highly correlated to the downside. While the FATMAAN names are showing signs of stress, the money there is looking for a new home in various individual stocks and sectors. This is some of the best stock-picking in years right now. There is no major macro issue that is driving corrective action. The cash out there is simply looking to go where it will be treated best.
If you want to find a reason to not trust this market then look at the indices and the FATMAAN stocks. If you want to try to make money then look at the best sectors and focus on stock-picking. The very bullish price action is hidden behind the bulk of the technology giants.
We have a positive open on the way and it will be interesting to see if small-caps, biotechnology, and stock-picking can gain further momentum.