When only a handful of mega-cap technology names prop up the entire stock market for months on end, people forget that the elevator goes in both directions. Then, when it finally goes down, it feels like the world is ending.

The world isn’t ending, but the nearly year-long rally in the S&P 500 and NASDAQ might be. The NASDAQ just entered into correction territory, which is defined as a 10%-or-greater pullback from the prior peak price.

Corrections are supposed to be normal and natural, but there’s nothing normal or natural about the stock market in 2023. There’s a lack of broad participation in this year’s stock rally, as the S&P 500 is skewed to the upside due to its market-cap weighting.

Since a few companies with gigantic market caps have outsized influence on the S&P 500, the entire index can climb higher simply because the so-called “Magnificent Seven” stocks (Tesla, Alphabet, Meta Platforms, etc.) are moving up.

In other words, if you exclude the performance of the seven biggest technology companies, the S&P 500 (or maybe you could call it the S&P 493) would actually be flat or even slightly down year-to-date. The lack of breadth in the stock-market rally this year, I’d claim, makes the S&P 500 and NASDAQ especially vulnerable to a pullback.

Courtesy: Bloomberg

Surely, it’s not a good sign that an equal-weighted S&P 500 index would underperform the market-cap-weighted S&P 500 so dramatically. The last time this occurred was in 1998, a couple of years before the dot-com bubble burst.

This is why it’s so difficult to time the markets. There was an evident stock-market dislocation in 1998, in which tech stocks zoomed higher while the rest of the market got left behind. Yet, it took a couple of years before the big reckoning actually happened.

On the other hand, we’re already seeing the NASDAQ start to crater during the current earnings cycle. Microsoft had decent earnings results for the third quarter, but Tesla, Alphabet, and Meta Platforms got clobbered by investors post-earnings-announcement.

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    Those are all “Magnificent Seven” companies that propped the S&P 500 up throughout 2023. Alphabet and Meta Platforms jumped headfirst onto the artificial intelligence (AI) bandwagon, as the shareholders have been obsessed with AI.

    All it took was a few mentions of AI during an earnings conference call, and these stocks would shoot higher. That’s not working anymore, though, and tech companies will now actually have to demonstrate growth, innovation, and fiscal discipline.

    Expect to see more of this in the coming months: whatever leads, now bleeds. Maybe the new leaders will come from the Dow Jones, which has mega-cap tech names but isn’t dominated by them.

    Or maybe, small caps will finally have their time to shine. The divergence between the NASDAQ and the Russell 2000 is cavernous at this point, and it can only resolve with the NASDAQ coming down further, or small caps coming up, or both.

    This isn’t to suggest that all small-cap companies deserve your investable capital. Crush the Street has consistently picked winners from the small-cap space, and you’re encouraged to conduct your own due diligence to find the market’s hidden gems.

    Hence, there’s no need to hide out in an all-cash position right now. We might be in the equivalent of 1998 now, with some time left before the tech reckoning occurs. Besides, there are smaller companies out there with excellent growth potential, if you know how and where to find them.

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