Stocks Are Increasingly Going Their Own Way. Here’s Why a Selloff Might Follow.

The stock market's "fear gauge" suggests a positive outlook for the S&P 500, but individual stocks within the index are increasingly following their own paths.

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Last week, the six-month implied correlation for S&P 500 members reached its lowest point ever, based on Cboe Global Markets data. This indicates that individual stocks in the index are less likely to move together as they used to.

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Implied correlation measures investors’ expectations on how stocks will move relative to each other in the future, using stock-option pricing. This gauge helps investors understand if stocks will move in sync or independently.

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Since the bull market began in 2022, realized correlation—how stocks actually move independently—has generally decreased. This decline has driven implied correlation to record lows. The divergence among stocks has increased sharply since the start of 2024, with a few megacap stocks masking losses from other index members.

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A clear example is Nvidia Corp., which has surged nearly 147% this year, becoming the second-best performer in the S&P 500. Only Super Micro Computer Inc., which joined the index in March, has outperformed Nvidia, driven by a spike in server demand.

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Analysts at UBS Group noted that Nvidia alone contributed more than one-third of the S&P 500’s 12.3% gain in 2024. Nvidia recently became the third U.S.-traded company to surpass a $3 trillion market capitalization and completed a 10-for-one stock split.

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Other megacap stocks have also posted substantial gains. Among the S&P 500's ten largest companies, top performers after Nvidia include Eli Lilly & Co. (up 48%), Meta Platforms Inc. (up 41%), and Broadcom Inc. (up 30%), according to FactSet data.

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However, 301 companies in the index have seen their shares decline in 2024. Nearly 130 of these companies have fallen by 20% or more, including well-known names like Tesla Inc. and Lululemon Athletica Inc.

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Despite the dominance of megacaps, 73 stocks in the S&P 500 are up 20% or more this year, according to FactSet. Yet, the percentage of stocks outperforming the index remains notably low for the second consecutive year, according to Richard Bernstein Advisors. This trend, except for 2023, makes 2024 the year with the fewest outperforming stocks since 1999. As of Monday afternoon, the S&P 500 had risen 12.2% year-to-date.

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The disparity is evident even within the AI sector. According to Bespoke Investment Group, AI beneficiaries worth over $1 trillion have averaged an 11.5% increase since April, while smaller AI-related stocks, particularly in software, have struggled.

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The winners include the six largest U.S. companies by market capitalization: Microsoft Corp., Apple Inc., Nvidia, Alphabet Inc., Amazon.com Inc., and Meta Platforms Inc.

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Dispersion during a bull market is typical, where winners and losers become more distinct, explained Jonathan Krinsky, chief technical strategist at BTIG. However, the extreme level of current dispersion is notable. Analysts are watching for when stock correlations might rise again, which could signal another market selloff.

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Krinsky suggests that a market rise and increased correlations are possible but would likely indicate a scenario where everything rallies together. More plausibly, correlations might rise from all-time lows as the market falls.

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Options traders currently see minimal risks, expecting the S&P 500 to remain stable over the next month. This is reflected in the Cboe Volatility Index (VIX), which was below 13 on Monday afternoon, remaining relatively low since hitting a four-year low in mid-December. The VIX typically rises when stocks fall and vice versa.

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As of Monday afternoon, all major stock indexes, including the small-cap Russell 2000, were trading higher. The S&P 500 rose 0.2% to 3,355, the Nasdaq Composite increased 0.1% to 17,156, and the Dow Jones Industrial Average climbed 50 points, or 0.1%, to 38,852.

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