Last week was the 5th consecutive gain for the S&P 500. Fourteen of the last 15 weeks have been positive. Prices are now up for the index over 20% since the lows from last October. The S&P is above 5,000 and at new all-time price highs. It’s been a great start for the stock market this year.
A big reason for the market gains is that the economy has been stronger than expected. For example, nearly 2/3rds of companies have reported earnings so far for the last quarter, and over 80% have bested expectations. That compares to a typical beat rate of 67% in a typical quarter (data going back to 1994).
There is a tide change, however, in what is driving the stock market. For months, it was primarily about interest rates — both what long-term rates were doing, and what the Federal Reserve might do. If rates went up, stock prices went down, and vice versa. Over the last few weeks, however, rates have moved higher and so has the stock market. In short, this is a stock market that wants to go higher. It is classic bull market behavior. Bull markets ignore bad news, and any good news is a reason to rally.
That said, I believe that a new risk may be starting to develop: the potential for a “melt-up market.” This is when prices shoot higher as more investors jump into the market based off of increasingly positive sentiment and FOMO (“fear of missing out”) on attractive short-term gains. Just like bear markets and corrections, melt-up markets can be destabilizing to many investors, threatening their focus on the proper investment principles of maintaining balanced and diversified portfolios created on their investment goals, and maintaining a long-term discipline.
It is notable that the top names in the stock continue to dominate the index gains so far this year. It is normal that markets can get concentrated at times, and it is also natural for that concentration to unwind. To everything there is a season. On that last point, despite strong relative performance in recent years, did you know that the largest names in the market tend to underperform — and by a far margin at that? In fact, according to a new paper by GMO last week, since 1957, the top ten stocks have underperformed the equal-weighted average of the remaining 490 stocks in the S&P by 2.4% per year. Since 2013, however, the top ten names have outperformed by 4.9% per year. The large cap outperformance in recent years really has been exceptional.
This week will bring the latest readings on inflation and consumer spending. On the corporate earnings side, about 15% of the S&P 500 is set to report earnings.
Add it all up...
Stay invested. Stay diversified. Stay disciplined.