How Well Is The Stock Market Really Doing?
The year 2021 is coming to an end and the stock market is experiencing a level of volatility not seen for some time. The stock prices of previously high-flying companies such as Facebook are down from their previous highs. Could this be the beginning of a major downturn?
One indicator that many technical stock analysts follow is market breadth. The valuations of most U.S. stock market indices – the DJIA being the notable exception – are based on the weighted average of the market capitalizations of the companies comprising the index. The market cap of each company is simply its stock price times the total number of outstanding shares. For example the biggest stock in the S&P 500 right now is Apple, whose current market cap represents about 6.8% of the total market cap of all the companies in the index. When Apple’s stock price rises by $1 the valuation of the S&P 500 will go up by almost $7. By contrast Under Armour (one of the smallest companies in the index) represents less than one-hundredth of one percent of the S&P 500’s valuation. Even if its stock price were to miraculously jump by $100, it would bump up the index by less than $1.
Market breadth is a measure of how many stocks in an index are actually participating in the movement of that index. Suppose the growth in the S&P 500 throughout 2021 was driven primarily by just a few companies with outsized market caps, and most of the remaining companies in the index had negative returns. That could be an indicator that there’s not a lot of support for further increases in market returns, and could even be a warning that the market could be turning around. On the other hand, if most of the companies in the index contributed to its price gains, one might conclude that that the overall economy appears to be doing well, a positive signal for continued stock market growth.
According to Yardeni Research, as of this writing about 85% of the companies in the S&P 500 have experienced year-over-year price gains. So it wasn’t just those few big tech stocks that drove its 20% gain so far in 2021. Nearly all the stocks in the index participated in the growth. That’s certainly a good sign that the market remains strong.
Unfortunately no one (including market breadth analysts) can predict the future. There’s no guarantee that a big downturn is not still looming just around the corner. So why am I bringing this up? Just to cheer up anyone who may be worried about market valuations and volatility right now. It’s easy to become discouraged as COVID, inflation, and supply chain issues rage on. This is one market measure that suggests things are still looking good for investors. Happy holidays everyone!