Market breadth – the number of stocks rising or falling within a benchmark – is one of the most important indicators for portfolio strategy. Changes in market breadth can determine the relative success of both active-versus-passive and value-versus-growth investing strategies.
Right now, the market breadth of the S&P/TSX Composite Index is narrowing. As a result, indexing and large cap, growth-oriented stock selection strategies are likely to produce better returns.
The chart below shows the relative performance of two different benchmarks for the TSX: The widely-followed S&P/TSX Composite Index, which is market cap weighted – larger companies have a bigger effect on performance; and the equal weighted S&P/TSX benchmark, where each stock's moves affects the index equally. On the chart, both benchmarks are indexed to 100 as of October, 2011 (when the equal weighted index began).
The widening lead of the cap weighted benchmark over the equal weighted one signals that market breadth is narrowing – in other words, positive performance is increasingly limited to fewer large cap companies, while smaller ones appear to be languishing. The trend also suggests that earnings growth is becoming more scarce. If profit growth were widespread, small and mid cap companies would drive the equal weighted benchmark higher.