Megacaps Mask S&P 500 Weakness as Breadth of Losses Worsens

  • Six of 10 groups have tested Aug. 25 low on equal-weight basis
  • Apple-Microsoft-Exxon make up a fifth of gains since selloff

Investors waiting for U.S. stock indexes to test their August low should be aware that more than a third of equities are already there.

While the Standard & Poor’s 500 Index is 1.9 percent above its worst closing level of 2015, almost 42 percent of the gauge’s members have slipped back below their Aug. 25 price. The heavyweights are doing all the lifting: Apple Inc., Microsoft Corp. and Exxon Mobil Corp., the three largest companies by market cap, account for nearly one-fifth of gains since the market bottomed after a four-day selloff of 10 percent.

“Investors are taking out the prior winners one-by-one and taking them to the woodshed,” said Lew Piantedosi, vice president of growth equities at Eaton Vance Management in Boston, where he helps oversee almost $14 billion. “There’s been a bit of a flight to safety recently” as investors favor larger-cap stocks, he said.

Megacaps are obscuring weakening breadth in U.S. equities. To some, that’s an ominous sign amid market volatility that has seen the S&P 500 slide as much as 7.4 percent over the past two weeks, coming within five points of a 10-month low of 1,867.61 reached Aug. 25. The benchmark gauge fell 0.6 percent to 1,908.04 at 12:39 p.m. in New York.

A version of the index that strips out market-weight biases, the S&P 500 Equal Weight Index, has already fallen past the level, closing on Monday and Tuesday below its Aug. 25 low of 2,931.78 before rebounding Wednesday.

Weighted for size, only two of the 10 major groups in the S&P 500, materials and health-care, are trading below the August threshold. That changes on an equal-weighted basis, as six industries, including consumer and energy stocks, have penetrated the level. Viewed like this, the benchmark gauge’s post-Aug. 25 rally dwindles to just 1.8 percent, rather than 2.8 percent when weighted for market cap.

Energy stocks have the biggest differential when gauging their performance, with the capitalization-weighted index up 4.4 percent versus 1.3 percent for the group on an equal-weighted basis.

Helping to keep this group afloat? Exxon, which has been “holding in there better than most of energy,” Piantedosi said. The stock has risen 8.2 percent since Aug. 25, after tumbling almost 26 percent in the preceding eight months.

Likewise, Amazon has buoyed consumer stocks, contributing to almost 20 percent of the sector’s post-August bounce. The group has gotten “really concentrated” in recent months after its run as one of the “big, persistent momentum leaders of the year,” said Jim Paulsen, the Minneapolis-based chief investment strategist at Wells Capital Management Inc., which oversees $351 billion.

Health-care stocks, meanwhile, offer a harbinger of what could happen more broadly, according to Paulsen. As investors piled into biotech, the high concentration in fewer companies has helped fuel a collapse, he said. The capitalization-weighted group now is trading 2.2 percent below its Aug. 25 trough.

“As the market comes undone, you do have leadership that holds on for a period,” Paulsen said. “But then there’s a slingshot effect and ultimately, these name have to catch up.”

Biotechnology’s plunge has “unnerved people,” but because the stocks have led the decline following August’s slump, they could lead the next rally, said Bruce McCain, chief investment strategist at Key Private Bank in Cleveland, the private-banking unit of KeyCorp that oversees more than $25 billion in assets. “It’s fairly typical for some of the best stocks to pull back pretty dramatically.”

Amid a broader flight to safety, what remains to be seen is how this plays out as the market finds its footing, McCain said. “The question is: Are we rolling toward a major bear market or is this simply a corrective action?”

While McCain’s in the latter camp, there could be further pain ahead as more groups test their August lows. “We don’t like to see the deterioration in the market, but you have to realize it’s a natural part of the process,” he said.

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