By Portfolio Solutions Group | Aug. 22, 2024

Portfolio Solutions Group (PSG) discusses one of the tools it uses to gauge overall market strength. Understand how market breadth can be a valuable tool for investors.

What is market breadth?

Market breadth is a metric used to gauge the overall strength of a market’s returns. It can be a valuable tool for investors to assess both the strength and sustainability of a market movement, beyond the price movement of an index such as the S&P 500 or MSCI ACWI[KK2] . Breadth can be measured by analyzing the number of securities that are advancing, compared to those that are declining. If more securities are participating in the market direction (for example, greater breadth), the trend is generally more sustainable and holds less risk than one led by a smaller number of stocks.

Some common indicators include advance-decline lines, looking at the number of stocks making new highs, and observing the percent of stocks above a moving average.

Market breadth in 2023-2024

One of the dominant themes in the past year has been a change in the breadth of the market. 2023 was a year of narrow market leadership, led by the Magnificent Seven stocks and investor optimism surrounding artificial intelligence.  While these tech giants soared, their stellar performance masked the uneven returns of the broader market, creating a facade of booming capital markets during a time when traditional economic indicators were providing mixed signals. During this period, while investors with diversified, balanced portfolios performed in line with long-term expectations, higher-risk investors who bet heavily on these behemoths were rewarded with outsized returns. 

Conversely, as economic data improved (for example, moderating inflation, resilient labour markets, and strong GDP growth) and investor sentiment turned more positive in the first quarter of 2024, market breadth broadened with more sectors and stocks participating in the gains. The second quarter of 2024 saw some economic challenges from rising inflation data, and overall breadth tapered off while remaining above 2023 levels.

Significance of market breath in PSG-managed portfolios

Long-term investors use market breadth to assess the risk and strength of returns in their portfolios. Strong, broad market breadth can signal a favorable environment where a diverse group of holdings perform well. Narrow market breadth may prompt investors to be more cautious and consider rebalancing their portfolios more frequently. 

PSG-managed portfolios are designed to spread risk across various asset classes, sectors, and geographies. When market breadth is strong, returns are spread across a wide range of stocks, benefiting a good portion of the equity component. This indicates a favourable economic environment, which can positively impact other parts of the portfolio as well (for example, real estate and corporate bonds). Conversely, narrow market breadth can signal potential volatility and concentration risk. For PSG-managed portfolios, this can mean that while broad indexes might appear to be performing well, gains are limited to a few sectors or companies. This can indicate increased risk and requires closer monitoring and potential tactical adjustments to ensure continued alignment with our investment views. As market breadth strengthens, PSG-managed portfolios can stand to benefit from the diversified strength of returns.

Over the past two years, market breadth has experienced significant shifts, reflective of broader economic conditions and concentrated investment themes such as artificial intelligence. For PSG, understanding and monitoring market breadth is crucial for managing risk and optimizing returns throughout a market cycle.

The views expressed in this commentary are those of this investment manager as at the date of publication and are subject to change without notice. This commentary is presented only as a general source of information and is not intended as a solicitation to buy or sell specific investments, nor is it intended to provide tax or legal advice. Prospective investors should review the offering and disclosure documents relating to any investment carefully before making a i decision and should ask their financial advisor for advice based on their specific circumstances.

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