The Path to Record Highs for Stocks is Becoming Increasingly Narrow. A Possible Reason for an Overdue Selloff.

On Tuesday, the S&P 500 and Nasdaq Composite achieved their 27th and 15th record highs of 2024, respectively. However, these milestones masked underlying market weaknesses, as much of the gains were driven by significant increases in Apple Inc.’s stock, which rose by 4.43%. Other megacap companies like Microsoft Corp., Alphabet Inc., and Meta Platforms Inc. also contributed to the index gains, while the majority of S&P 500 stocks declined, according to TradeAlgo's data.

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Even Nvidia Corp., responsible for 34.5% of the S&P 500’s 2024 advance according to Apollo’s Torsten Slok, closed lower on Tuesday. The only sectors that posted gains were information technology and communications services, dominated by the "Magnificent Seven."

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This concentration of market gains in a few elite stocks has led some strategists to speculate about an impending pullback. Market breadth, or the number of stocks participating in the market's advance, has been weak for some time, yet this has not significantly impacted the large-cap indexes.

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An unusual pattern appeared on Tuesday that has historically preceded market tops. Grant Hawkridge of AllStarCharts noted on social media platform X that the record highs were accompanied by more New York Stock Exchange-listed companies hitting new lows than new highs—a rare divergence. This phenomenon was last seen in late 2021 and late 2018, both of which were followed by market selloffs.

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Additionally, Jason Goepfert, founder of SentimenTrader, highlighted that declining NYSE stocks outnumbered advancing ones, with trading volume favoring the declining stocks. The simultaneous occurrence of these indicators is rare, last happening at the market peak in late 2021 and before that during the dot-com bubble peak in March 2000.

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Further emphasizing the market’s concentration, Todd Sohn of Strategas pointed out that three stocks—Microsoft, Apple, and Nvidia—now each comprise more than 6% of the S&P 500, a first since at least 1990. These three companies collectively account for over 20% of the index’s market capitalization, as reported by TradeAlgo.

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Despite these warning signs, bullish investors argue that the concentration of market returns is justified by the strong earnings and sales growth of these megacap companies. They also note that stock market records tend to lead to more records, suggesting continued upward momentum.

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This positive outlook was supported on Wednesday by a favorable May Consumer Price Index (CPI) report, which sparked rallies in both stocks and bonds. As a result, all three major U.S. indexes—the S&P 500, Nasdaq, and Dow Jones Industrial Average—were trading significantly higher on Wednesday morning.

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In conclusion, while the S&P 500 and Nasdaq continue to reach new highs, the market's gains are heavily concentrated in a few megacap stocks, raising concerns about the broader market’s health. Historical patterns and current market signals suggest caution, but strong fundamentals and positive economic reports provide reasons for optimism among bullish investors.

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