Finance: Trouble is lurking under the surface of the stock market

A stock market hovering near record highs is masking some turbulence under the surface in smaller companies and underperforming sectors.

• The stock market isn't performing quite as well as it appears if you strip out the market cap weightings from the S&P 500
• When a small number of stocks do a big portion of the lifting for an index, that can be problematic down the line
• A weaker-than-expected dollar is also helping bifurcate performance in the US stock market

As mega-cap tech goes, so does the broader S&P 500.

The S&P 500 is a market capitalization-weighted index, meaning that the most valuable companies in the index have the biggest weighting. Apple, Microsoft, Facebook and Amazon alone make up a whopping 10% of the index on a weighting basis, for example, despite accounting for less than 1% of the total number of companies included.

With each of those four stocks up more than 16% year-to-date — and with three of them surging at least 31% — the S&P 500 has enjoyed an almost 11% climb in 2017.

But what happens if you strip out company weightings? Is the S&P 500 still a beacon of strength?

Not quite. The benchmark's equal-weighted counterpart, which gives every constituent in the index the same weighting, has only risen 8.4% this year, lagging the regular S&P 500 by more than two percentage points. And the divergence between the two gauges has been accelerating, with the equal opportunity S&P 500 having just completed its worst week of the year versus the market cap-weighted version.

So what does it all mean? Put quite simply: the foundation of the US stock market isn't as strong as it looks on paper. Less publicized industries are faltering under the surface as mega-cap juggernauts continue to impose their will on the overall direction of the market.

One big reason for this divergence is a weaker-than-expected US dollar. Down roughly 9% this year, the slumping greenback has helped the bottom line of multi-national companies by making their exports more lucrative. And wouldn't you know it, the conglomerates enjoying that earnings tailwind the most are also the ones with the biggest index weightings.

Meanwhile, smaller, more domestically-focused companies with weaker pull over stock indexes are failing to get a similar boost from the weakening currency. As such, the Russell 2000 of US small-cap companies has risen just 4.3% this year, less than half the S&P 500.

There has also been some turmoil under the surface of the stock market on a sector basis. Energy stocks in the S&P 500 have slumped 14% this year as crude oil prices have struggled to find footing. The resource slipped into a bear market in late June, throwing cold water on a sector that was just starting to pick itself up off the mat and expand profits.

Phone companies have also struggled, falling 9% in 2017. Frequently used as bond proxies due to their regular dividend payments and risk-averse profile, telecom stocks have come under pressure as the Federal Reserve has hiked interest rates, damping the appeal of their yield.

To be sure, stock market breadth — a measure of how concentrated gains are — is not yet at levels that are low enough to truly be deemed worrisome. A Morgan Stanley equity risk indicator that factors in breadth is still in neutral territory, supporting this notion.

Ultimately, narrow market leadership and flagging breadth are just two pieces to a much more complicated puzzle for stocks. Investors and strategists alike are increasingly flashing warning signs, but nothing has been drastic enough to truly spook traders. Yet.

from pulse.ng - Nigeria's entertainment & lifestyle platform online