Another reason not to fear the top-heavy stock market rally

By Stock News On Jan 25, 2024 5 0

This is The Takeaway from today’s Morning Brief, which you can sign up to receive in your inbox every morning along with:

Large-cap tech stocks ripped higher Wednesday for the fifth straight day — up to another record high, widening their lead over the broader market.

Many investors remain skeptical of the gains this year, as a handful of tech-centered stocks are once again accounting for nearly all the returns in the S&P 500. Comparisons with the dot-com-era boom and bust abound.

To be fair, we have never seen tech at such lofty levels relative to the broader market, as we can see in the chart below, which tracks the ratio between large-cap tech and the S&P 500. Yet, as is often the case in finance, how we got to these elevated levels is much more important than the levels themselves. Pace and direction trump elevation.

Astute chartists and technicians can point to a two-decade-long cup-and-handle pattern, which recently broke to the upside. (The cup is the U-shape, and the handle is the sharp drop after the top of the “U.”) In general, the bigger the base, the bigger and longer the breakout, goes the maxim.

To the skeptical and those uninitiated in the dark arts of technical analysis, human behavior manifests in ways that create repeated chart patterns across stocks, bonds, indexes, and every conceivable combination thereof.

“Buy low, sell high” is the time-tested Wall Street mantra. It’s no surprise, then, that bottom fishers try to buy new lows and permabears sell new highs. The former get beat up in bear markets and the latter get slaughtered in bulls.

Suffice to say, when it comes to investing, human nature tends to kick in at the worst times. Fear grips many investors and leads them to sell winnings or outright short the market during bull markets making new highs. Meanwhile, greed tempts investors buying stocks getting cheaper during bear markets.

And as investors figure out what to do, it pays to be circumspect about these factors. The past doesn’t guarantee the bullish pattern will repeat itself. But along with my colleague Julie Hyman’s point in the Morning Brief Tuesday about sustained — but narrow — rallies, it’s yet another data point for skeptical investors to weigh against their discomfort with a stock market powered by a concentrated few.