Does the market outlook depend on a few stocks?
The S&P 500 Index exploded to the upside with gains of 29% in 2019. In 2020, it returned a respectable 16% and another impressive 27% in 2021.
The 2021 market rallied on the backdrop of low interest rates, massive government stimulus, and a sharp rebound in corporate earnings from the pandemic bottom the year before.
Most of the stock market's gains from last year came from a handful of stocks, namely the six to seven mega-cap technology names: Apple (AAPL – 2.76T Mkt-cap and 7.11% of SPX), Microsoft (MSFT – 2.18T and 5.96%), Amazon (AMZN – 1.57T and 3.61%), Alphabet (GOOGL – 1.75T and 2.17%), Tesla (TSLA – 907.15B and 1.98%), and Meta/Facebook (FB – 565.39B and 1.38%).
With the proliferation of indexed-based funds, Exchange Traded Funds (ETFs), and other passive funds, the US stock market has become increasingly reliant on the performances of the largest companies in the S&P 500. Despite the sharp setbacks this year, the above seven stocks account for nearly 25% of the total market capitalization of the S&P 500 index. The same seven names comprised 49% of the technology-laden Nasdaq 100 Index.
So far, the 2022 stock market forecast looks to be quite challenging. To return to the long-term yearly average return of 8%, SPX must weather a host of new risks this year. New waves of Covid-19 variants have not derailed the US economic recovery. Inflation and Fed’s response are the wild card. With Congress deadlocked on another massive spending bill, geopolitical tensions escalating in Russia and Ukraine, and the Fed transition from easy to a restrictive monetary policy, investors have become fearful of risks.
The strength of the major indexes in 2021 came from a few large-cap technology names. In the latter part of last year, cracks developed below the market surface. Market breadth contracted, and sector rotations became increasingly erratic. Although sector rotation is a normal part of the stock market cycles, it is not healthy that many sectors, industries, and stocks slipped into bear market territories.
Does the emergence of the omicron variant suggest the pandemic is transitioning toward endemic? Will supply-chain bottlenecks and shipping disruptions over the past two years abate? Will the sharp rise in energy prices slow during the second half of the year? Is inflation transitory?
With so many unknowns, the market is looking for new drivers to entice investors to return.
Although we have not witnessed a cyclical bear decline in 13-years there is a risk that at some point, major US stock market indexes will succumb to another major selloff?
Enclosed below are updated technical levels for the largest components of the S&P 500 Index and Nasdaq 100 Index. Will the performances of the six mega-cap technology trigger a cyclical bear decline or the resumption of the structural bull?