Concentration Risk and Lopsided Performance

The recent record close of the S&P 500 may have initially sparked confidence among investors. However, according to Jonathan Krinsky, chief market technician at BTIG, there are several reasons to be apprehensive about an impending pullback.

Krinsky points out that concentration risk is once again becoming prevalent. The megacap technology stocks, which played a significant role in driving the 2023 rebound rally in U.S. equities, have been outperforming unprofitable technology stocks and almost every other sector in the market over the past two weeks.

By comparing the performance of megacap technology stocks with that of unprofitable technology stocks, Krinsky's data reveals that the margin of outperformance by megacap tech is the widest it has been since May 2022.

Moreover, a considerable divergence is observed between the small-cap-focused Russell 2000 (RUT) and the Nasdaq-100 (NDX). After a brief period of simultaneous rise towards the end of last year, the Nasdaq-100 has surged ahead since the beginning of 2024, while small-caps have retreated.

As a result, small caps now lag behind the Nasdaq-100 by approximately 8% over the past 15 trading days through Friday - the largest gap seen since March 2023.

It is worth noting that small-cap stocks and several top holdings from the ARK Innovation ETF (ARKK), which is often considered a proxy for unprofitable technology names, are not included in the S&P 500.

Furthermore, another troubling divergence has emerged between market-based expectations for interest-rate cuts and the performance of the S&P 500 (SPX).

Market Expectations for Fed Rate Cut Decrease Significantly

Market-based expectations for the Federal Reserve to deliver its first interest-rate cut in March have experienced a sharp decline since the beginning of 2024. The CME Group's FedWatch tool indicates that these expectations have fallen from approximately 90% in late December to 46% as of Monday.

Uncertainty Surrounding US Stocks and Fed Rate Cuts

According to experts, the belief that US stocks will continue to rise despite dwindling chances of an immediate start to Fed rate cuts is dubious. While correlations between different factors within the market are not permanent, it is reasonable to assume that a substantial portion of the rally observed since October was driven by the anticipation of rate cuts beginning in March. Consequently, this divergence between market expectations and rate cuts is likely to culminate in the S&P 500 moving lower in the near-term.

Reliance on Megacap Technology Stocks

In January, megacap technology stocks experienced significant outperformance. Despite this, an unexpected volume of trading in S&P 500 stocks has been lower rather than higher. This reliance on a select few megacap technology names to drive major indexes like the S&P 500 and Nasdaq-100 higher is concerning. Furthermore, many of these names, particularly in the semiconductors sector, are already showing signs of exhaustion. As a result, without broader participation in the rally, further upside for the S&P 500 is expected to be limited.

Positive Open for US Stocks

On Monday, US stocks opened on a positive note, potentially setting the stage for the S&P 500 to achieve a second consecutive record close. At the time of writing, the S&P 500 was up by 0.5% at 4,862, while the Nasdaq Composite gained 0.4% to reach 15,426. The Dow Jones Industrial Average also saw an increase of 137 points, or 0.4%, bringing it to 37,997.