U.S. Equity Market Leadership: Time For A Change? – July 15, 2024



A just-published report highlighted some significant distortions in the U.S. equity market, which we expect will unwind going forward.

For instance, equity market leadership normally narrows when credit spreads widen, and vice versa. This inverse relationship makes intuitive sense since narrow credit spreads typically reflect healthy economic and corporate fundamentals whereas widening credit spreads are a sign of mounting concerns about economic prospects and the corporate profit outlook. The largest-cap stocks usually outperform the broader market when credit spreads widen as investors seek safety in higher-quality equities when economic uncertainty rises, while the opposite is true when credit spreads narrow.

In the past 18 months, the equity and credit markets have been sending conflicting signals, with the S&P 100 index significantly outperforming its broader counterpart despite corporate bond spreads tightening to historically narrow levels. Either credit spreads will widen and validate the extreme outperformance of mega-cap stocks, or they will remain well behaved, as we expect, and equity market leadership should broaden.

The report noted other divergences in earnings growth, valuations, risk attitudes and technical conditions, concluding that prudence dictates diversifying exposure away from the top-end of the equity market.

 





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