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Broader views of market movements

Beyond the mere direction of stock indexes, investors can gain insights from knowing the number of companies involved in rallies and sell-offs. Dave Sandstrom talks about the importance of market breadth in a Money Talk Video interview with Kyle Tetting. Their discussion was part of the virtual 2021 Investment Outlook Seminar.

Kyle Tetting: Dave, it feels like we’ve gone through periods in time in the market where there’s a small number of stocks that really have led the market higher. And of course, there’s some reasons why that is, but as importantly, there’s some ways we measure that. Can you tell us a little bit more?

Dave Sandstrom: Kyle, I think you’re referring to market breadth. It’s an indicator that measures how many stocks or how many companies are participating in the market’s current direction.

Kyle: And as we think about some periods in time in which it may have been a small number of stocks leading higher, there are certainly reasons why that would be. So you go back to the FAANG (Facebook, Amazon, Apple, Netflix, Google) stocks that had really been the key to driving things higher for much of the last couple of years. I think it’s critical to understand why.

Dave: Kyle, it’s a good point. And I think one of the time frames specifically was during the pandemic when people were quarantined and those tech stocks really had the ability to penetrate homes, reach those customers, and we saw periods of time where just a handful of stocks were driving the market substantially higher.

Kyle: There are some reasons why investors might be worried about that. If it’s only a small number of stocks that are really the key to market returns, the broader economy may not be participating.

Dave: That’s correct. And I know that we’d like to see broader participation. If we have more and more companies participating in the upside, typically that’s an indication that it’s a healthy economy, and not necessarily so with only a few companies participating. But to your point, it certainly doesn’t mean that there is a good reason why those companies are doing well and why it can’t continue.

Kyle: And I think what’s interesting is that we’ve seen a transition to more businesses, to more companies participating in those days where the market runs higher.

Dave: And I think to your point earlier about there’s a good reason for that, this year, the economy is reopening. So we have much, much broader participation, with corporations in this country being able to access consumers again, people getting back out. So yes, participation has broadened greatly.

Kyle: And to maybe take that a step further and say that it isn’t necessarily even just about a small number of stocks or a small corner of the market, but to look even more broadly at growth versus value, as an example. Those technology names that we often talk about kind of fill that growth side of the bucket. There’s a reason why growth may be an area that tends to lead.

Dave: That’s correct. And it’s because, by definition, growth stocks are going to pour all those profits back into growing the value for shareholders and keep that thing going. But I think it’s to really look at it from a standpoint of, as an individual investor, it’s the diversification in the portfolio that is the important piece to that. Because we don’t want to make a guess on value or growth or any sector in particular. We want to make sure that the portfolio addresses all of those sectors so that when market breadth does narrow, we don’t miss out. We’re still going to gather some of that return.

Kyle: And I think that’s critical. There’s always this question of what do investors do with this information? What do we do with the idea that it’s a small number of stocks that’s leading markets higher? And there’s a tendency to want to chase those ideas. There’s a tendency to want to say, ‘OK, you know, these 10 stocks, the largest 10 in the S&P 500, account for roughly 30%, as an example. If those are the 10 names that are moving higher, you want to put more of your portfolio in there.’ But I think there’s also maybe some reasons why you might want to think more broadly about the world.

Dave: I think it’s dangerous to take one indicator such as market breadth and make comprehensive decisions for your portfolio based on that. You know, we saw it last year in 2020. That narrow market breadth that we talked about, it abruptly changed this year as the economy reopened. And if you would have adjusted based simply on that particular measure, you’d have been in trouble this year as far as missing out on a much broader participation.

Kyle: And of course, there’s no reason to think that it may not be a different six or seven companies that lead the next wave of recovery.

Dave: Correct. So that’s why that diversification is such a critical piece of portfolio management.

Kyle: As we think more broadly about our portfolio, we talk about market breadth within the stock market, but I think it’s fair to also point out that within different asset classes, we can see leadership change. That it might be stocks that carry your portfolio for a while, but at some point in time, stocks are going to have a correction, stocks are going to have a bad day, and you need to look to other pieces of your portfolio.

Dave: Those other asset classes are going to be critical in keeping you out of trouble, Kyle. And we’ve seen it recently as well with the bond market having tremendous returns in 2020 and struggle a little bit this year. So you see, that shift can occur even on some of the safer assets, but certainly you need those to provide that ballast for when the stock market starts to go through some of those changes.

Kyle: Dave, thank you very much.

Dave: Kyle, it was a pleasure.

Dave Sandstrom is vice president and investment advisor at Landaas & Company.

Kyle Tetting is research director and investment advisor at Landaas & Company.

Learn more
Support for stocks, beyond the calendar, by Kyle Tetting
Concentrated gains, broad participation, by Kyle Tetting
2021 Investment Outlook Seminar, a Money Talk Video
(initially posted October 29, 2021)

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