Nvidia Is Hiding The Cracks Beneath The Stock Market Surface

BING-JHEN HONG It has become a tale of two markets: those indexes with Nvidia and those where NVIDIA (NVDA) is neutralized or absent. The indexes that either have Nvidia as equal weight or are absent altogether have struggled since peaking in March, while market cap-weighted indexes with Nvidia have made new highs. The indexes with Nvidia give a false sense of comfort and belief that the equity markets are strong, and for those who do not assess the risk correctly, it could be a costly mistake down the road. Breadth Is Weaker While some might have you believe that market breadth is broadening, it not only hasn’t, but it has been narrowing. The advance-decline line for the S&P 500 peaked in the middle of May and has been trending lower since, while the S&P 500 has gone on to make a new high. StockCharts.com This has also been the case with a broader measure, as noted by the New York Stock Exchange Advance-Decline line. That advance-decline line peaked in the middle of May as well and has been trending lower since. StockCharts.com StockCharts.com New Highs Vs. New Lows The number of stocks making new highs versus new lows on the NYSE is also falling. This peaked in mid-March at 425 and has been trending low since. The most recent new high came on June 12, just 131. StockCharts.com What’s worse is that the cumulative number of stocks on the NASDAQ making new highs minus new lows has typically trended in the same direction as the price action over the past 40 years. But that has not been the case for more than a year now, with the cumulative number of new highs minus new lows continuing to fall even though the NASDAQ has seen a massive rally. StockCharts.com Nvidia Overwhelms The data since the middle of May shows that Nvidia has wholly overwhelmed the market. The Bloomberg 500, which can be used as a proxy for the S&P 500, has advanced by 2.46% and shows that since May 17, Nvidia has accounted for 81.1% of the gains in the Bloomberg 500 and that 156 stocks have moved up while 345 have moved lower. Apple (AAPL) is the second-biggest gainer, adding 29.9%. This means that the Bloomberg 500 would be lower without Nvidia and Apple. Over that same time, the S&P 500 rose by 2.54%, with 153 stocks advancing and 351 stocks declining. Bloomberg The narrowing of the breadth has been a theme for not weeks but months. The narrative started with the Magnificent 7 in the summer months of 2023, which turned into a group of just three by the start of 2024. But now, it seems to be a convincing one left to carry the rest of the market while breadth deteriorates and the more balanced equal weight indexes trend lower. The S&P 500 Equal Weight ETF (RSP) has fallen four weeks in a row, which amounts to a decline of about 3%, which is not much on its own, but compared to the market cap weighted S&P 500 ETF (SPY), which has advanced more than 2.5% over the same time. TradingView The RSP hasn’t even been able to surpass its highs since last seen in March, and has moved sideways more or less over that time. That could be said of the Dow Jones Industrials and Transports and the Russell 2000. TradingView This isn’t to say that the market is due for a violent move lower, but it is to say that once Nvidia sees a turn in momentum, its influences wane, and they will wane at some point; that the true nature of the market will take over again. For now, even if something changes beneath the surface in the market, the S&P 500 and the NASDAQ 100 mask that weakness because Nvidia can essentially cover that weakness up. Paying More But Getting Less What is also extremely odd about this market is that the blended 12-month earnings growth is expected to be 12.3%, with a 4.25% 10-year rate and a PE ratio of about 21. Meanwhile, in 2017 and 2018, the blended growth rate was north of 12%, with a 10-year Treasury rate of 3.25% or lower and a PE ratio of about 18.5. So, in theory, one is getting a much higher risk-free rate of return, getting lower growth, but paying a higher multiple to own the overall index. Bloomberg The other odd thing is that monetary policy today is much tighter than it was during those times, which calls into question why investors are willing to pay more to own the index today than in the past. Bloomberg When looking at the S&P 500 Equal weight, we find that PE multiples today are comparable with where they were in the 2017 and 2018 periods. Today’s growth rate is less at 4.25% versus a growth rate of 10% or more during 2017 and 2018 and a lower 10-year rate. So again, we find here that the market cap weight indexes are likely being distorted by just a handful of names, much more so than in the past, and at this point, it would seem that much of that distortion is due to just one stock. Still, investors seem willing to pay the same multiple for less growth. Bloomberg At this point, the market is not as strong as it appears, and it appears strong because Nvidia is just able to mask the weakness of the breadth beneath the surface. Perhaps this will last some time longer, and the game can be played until Nvidia reports in August, but at some point, if the breadth continues to weaken and indexes continue to diverge, then being alert is about the best you can do.

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