Morgan Stanley sees U.S. stock momentum eclipsing breadth

Investing.com -- Momentum seems to be taking precedence over the traditional indicator of market health, breadth, according to Morgan Stanley (NYSE:MS ).

This shift emerges as stock indices remain near all-time highs despite December showing some of the poorest breadth in history, a development that typically would signal caution.

The firm pointed out that the lack of broad participation among stocks, which began to deteriorate at the start of December, coincided with a rise in 10-year U.S. Treasury yields above a critical 4.5% threshold. This increase in yields has historically acted as a headwind for stocks, flipping the correlation with equity multiples to negative.

Investors have increasingly been focusing on price momentum as a key investment strategy, allowing winners to run without rebalancing, which has led to extreme concentration in equity markets globally.

“Quality is a very crowded factor, and it’s a global phenomenon. In fact, quality is more expensive outside the US, given the lower proportion of quality companies in rest-of-world (ROW) indices,” Morgan Stanley strategist Michael J. Wilson said in a note.

“This is a major reason why the S&P 500 trades at a substantial premium to foreign indices and lower-quality cohorts like small- and mid-caps.”

“Nevertheless, this focus on price momentum and the resulting concentration may explain the disconnect between breadth and price and why many were willing to ignore its warning until this week,” Wilson added.

The strategist also notes a persistent disparity between the S&P 500 index as a percentage of its 200-day moving average and the percentage of S&P 500 stocks trading above their 200-day moving average. This spread has remained wide for an unusually long time, similar to what was seen in 1999 and from April 2023 to the present.

The current divergence began when the US $2.5 trillion reverse repo facility peaked in April 2023, alongside a US $500 billion injection of reserves following regional bank failures that spring. The analysis suggests that the anomaly between breadth and price may normalize if the abundant liquidity provided by the Fed decreases.

Wilson emphasizes that high-quality indices with strong price momentum may be less affected by breadth than in the past. He advises staying focused on high-quality stocks, as the market has reset prices this past week, indicating that expensive growth stocks and low-quality cyclicals could be most at risk if interest rates remain higher for longer and liquidity lessens with the winding down of the reverse repo facility.

Source: Investing.com