For months, I have been discussing the likely implications of deteriorating market breadth. For instance, fewer and fewer components are holding up the Dow, the S&P 500 and the NASDAQ. Only a small number of industry sectors are keeping the popular benchmarks in the plus column. Similarly, half of the stocks in the S&P 500 currently demonstrate bearish downtrends. And declining stock issues are significantly pressuring advancing stock issues for the first time since July of 2011.
Historically, when a handful of stocks like Amazon (NASDAQ:AMZN), Apple (NASDAQ:AAPL), Facebook (NASDAQ:FB), Gilead (NASDAQ:GILD), Google (NASDAQ:GOOG) and Walt Disney Co (NYSE:DIS) account for all of the gains for a major index like the S&P 500 – when 250 of the index constituents show bearish patterns – the narrow breadth tends to drag the benchmark’s price downward. To be fair to the bull case, the major indices have held up so far. Nevertheless, U.S. equities in the Dow and the S&P 500 have been churning sideways for the better part of seven months.
What about the prospect for underperforming sectors of the economy contributing to widespread market gains? I wouldn’t hold my breath on the possibility of wider breadth in the near term. Materials and resources-related companies continue to be plagued by slumping oil and weak commodity demand around the globe. Most economists believe that while the rout in commodities may conceivably abate, a significant increase in global demand or a sharp decline in global supply is unlikely. In the same manner, the manufacturing segment’s pullback may be structural, not cyclical. Miners, industrial conglomerates and utilities probably won’t be getting wind at their back anytime soon.
For better or worse, the primary hope for continued appreciation in the U.S. indices rests atop the shoulders of the healthcare juggernaut, dot.com usage and the iPhone-oriented consumer. Indeed, investors have been remarkably willing to pay almost any price for the growth of the “Facebooks” and “Gileads” of the world.
On the flip side, can the market-cap behemoths do any wrong? Of course they can. It wasn’t so long ago that Facebook shares face-planted for a 50% loss out of the IPO gate? Similarly, Apple tumbled 45% at the tail-end of 2013. Even at this moment, questions about the viability of the iWatch and the corporation’s ability to grow at a rapid pace in future quarters is keeping the shares of the largest company on the planet from breaking through resistance.
For the time being, however, let’s assume that the “Big Six” identified earlier maintain their proverbial cool. And let’s assume that the narrow breadth in the U.S. benchmarks (as well as sky-high stock valuations) are not enough to dent the positive impact provided by health care and retail/consumer stocks. Is it possible that waning enthusiasm for foreign equities might couple with the weakness in U.S. market internals and sky-high valuations to eventually topple the major U.S. benchmarks?
Looking back to the last stock market smack-down might provide some clues. Specifically, in 2009 and 2010, stocks throughout the world staged a revival. What’s more, in the same manner as they had in the previous decade, foreign stocks significantly outpaced U.S. stocks in 2009 and 2010. In fact, the global growth theme that dominated the initial decade of the 21st century remained in the driver’s seat. The dominance ended in October of 2010, however. Not only were the “emergers’ emerging at a slower pace, particularly China, but central bank stimulus supplanted the global growth story altogether.
Consider the Vanguard FTSE All-World ex US (VEU):S&P 500 SPDR Trust (SPY) price ratio below. VEU:SPY began descending in the 4th quarter of 2010. The fading relative strength for VEU:SPY cemented itself early in 2011, when 200-day trendline support shifted to resistance. Not only did the weakness in U.S. market internals matter in July 2011 via the NYSE Advance Decline (A/D) Line, but relative weakness in foreign stocks also mattered. Fewer and fewer U.S. stocks were participating in the rally by July of 2011 and fewer and fewer international stocks were participating in the worldwide equity rally.
It is worth noting that the deterioration of the VEU:SPY price ratio over the last three months of 2015 may be another headwind to U.S. benchmark gains. Historically, all stock assets typically exhibit positive correlations. It follows that, if foreign stocks are faltering at a time as when half of U.S. stocks are in their own downtrends, it may be reasonable to assume that the major U.S. benchmarks could buckle.