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A banking crisis, the debt ceiling, recessionary fears, and increasing global tensions are reasons investors are fearful.  Yet you may have noticed that the US stock market has been acting kind of strange lately. So, let’s talk about what is happening with the US stock market – specifically large-cap stocks – many people think of the S&P 500.

Regardless of your model, we must remind you that you only have a portion of your portfolio in the US market, consistent with the science behind investing and managing risk.  A moderate portfolio has 12% in the large-cap stock.  Still, this is an important asset class, and you might be wondering what is going on, are we headed towards a bull market rally, or is this a head fake – a bear market trap?

In sports, a head fake is when someone moves the head to fake an intended change in direction, thereby deceiving opponents​.

The term originated in sports, but it has become applied metaphorically to the financial markets; a head fake refers to a time when the market appears to be moving in one direction but ends up moving in the opposite direction. Market strategists are concerned about recent gains sparking the current bull-bear debate.

What is causing this concern?  Valuations are high, and the number of stocks driving gains is low and concentrated at the top of the cap spectrum.  The lack of participation from the rest of the stock market warrants caution.  The troubling aspect of the market’s advance this year can be seen by observing three indices used to monitor the market. The chart below shows a significant divergence year-to-date; the QQQ is up 30.8%, the S&P 500 is up 9.5%, and the RSP is down -.1%.

You may recall that RSP, the equally weighted stock index was the top performer in 2022 compared to the other cap-weighted indexes.  The YTD underperformance is concerning since this type of underperformance could be a harbinger of a further decline in the market.

While RSP is equally weighted with exposure to .2% of each company in the index regardless of its size, the S&P index is cap-weighted, exposing its movement to the most significant five mega-cap stocks: Microsoft, Amazon, Google, Tesla, and NVIDIA, which account for over a quarter of the capitalization of the S&P 500 index. These five companies are viewed as clear winners in the coming AI revolution, as they are providing the underlying AI infrastructure. Investors are bullish on AI as it is expected to grow to a $2+ Trillion industry by 2030. It should be noted that shares in small artificial intelligence companies have also soared this year due to the hype surrounding AI and ChatGPT models.  These five most extensive stocks outperformed the other 495 stocks this year in March and this month. 

The lack of participation in the rest of the market has many concerned.  Leading analysts warn of a “speculative bubble in the making. According to CNN, “The AI stock mania is reminiscent of other speculative crazes in the tech world. Consider what happened with the crypto-related stocks in 2022 after soaring in 2021.  And let’s not forget the epic rise of many dot-com companies in the late 1990s and their subsequent plunge in 2000.”  The graph below shows that the S&P took 13 years and the NASDAQ 15 years to return to even during that cycle.  We expect AI to go through a similar process of exuberance during the initial innovation period to disillusionment before there is steady market growth. Also, the winners may not be the same companies we see in this space.

Like the personal computer revolution, the initial innovators did not benefit from the technology. Commodore sold the world’s best-selling desktop computer in 1985, only to declare bankruptcy ten years later.  Texas Instruments and Tandy were known for their earliest mass-produced personal computers, yet other companies passed them over. 

Regardless of your perspective, whether you are focused on potential economic triggers which have you fearful or on trends you believe can predict the market which sparks your greed, a disciplined investment approach, a strategy that exposes you to the needs enough but protects against significant market declines has been proven to be the most successful over the long run. A scientifically developed strategy will keep you invested long enough to reap the benefits of staying the course.