NVIDIA Soars, but Laggards Spark Concern on the Stock Market

While America loves a winner, it’s the underperformers—numerous in number—that are beginning to garner attention in the stock market.

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Kevin Gordon, senior investment strategist at Charles Schwab, told MarketWatch that while megacap stocks have benefited from momentum this year, there’s a more significant story beneath the surface.

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This momentum was evident as Apple Inc. caught up with artificial-intelligence chip maker Nvidia Corp., adding another 9% gain this week. Apple, boosted by its "Apple Intelligence" initiatives, surged over 7%, vying with Microsoft Corp. for the title of the most valuable company.

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Despite these successes, the broader market is struggling. A small group of megacap winners is increasingly dominating the market-cap-weighted S&P 500 and Nasdaq Composite. The S&P 500 has risen 2.9% in June, bringing its year-to-date gain to 13.9%.

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In contrast, the equal-weight version of the S&P 500, which gives equal importance to each component, is down 0.4% in June and has gained only 4.4% year to date. The Dow Jones Industrial Average, more cyclically oriented and price-weighted, has fallen 0.3% in June and is up just 2.4% this year.

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The S&P 500 has hit record highs despite fewer than half its members trading above their 50-day moving average. Mark Hackett, chief of investment research at Nationwide, noted that the five largest stocks accounted for half of the year-to-date gain, with Nvidia alone contributing 32%. These five stocks now represent a record 27% of the index’s market capitalization.

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Examining individual member performance, the S&P 500 has reached correction territory with a -15% drawdown, while the small-cap Russell 2000 and Nasdaq are in bear market territory at -28% and -37%, respectively. This poor market breadth explains why CNN’s Fear and Greed index now stands in “fear” territory, according to analysts at Bespoke Investment Group.

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Gordon emphasized that market concentration itself isn't particularly alarming. Historically, a few stocks often drive significant gains during rallies. The concern arises when a few stocks soar while the rest of the market struggles. This pattern was observed in 2021, leading to the 2022 bear market. Although history may not repeat exactly, investors need to stay vigilant.

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Economic signs of a “soft patch” contribute to the market's broader weakness. U.S. GDP growth for the first quarter was revised down to 1.3% from 1.6%. While nonfarm payrolls remain strong, there's a post-COVID normalization of the labor market. The services sector appears more resilient than manufacturing.

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This economic softness explains why cyclical sectors like energy and financials led the S&P 500 downward this week, dropping 2% and 2.3%, respectively.

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Gordon doesn’t foresee a major economic downturn but anticipates a market test.

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The market has undergone a rigorous cost-cutting cycle and is now waiting for revenue growth to resume. If this growth does not materialize as market breadth declines, the market could be vulnerable to a correction.

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In summary, while megacap stocks have thrived on momentum, a significant portion of the market is floundering. This disparity, coupled with economic uncertainties, poses challenges for investors. Historically, concentrated gains among a few stocks have preceded market downturns, underscoring the need for caution. The current economic conditions, marked by slow GDP growth and sector-specific weaknesses, further highlight the market's vulnerability. Investors must watch closely to see if revenue growth can pick up, mitigating the risk of a broader market correction.

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