What to Make of This Very Weird Market

It isn’t just you. The market is weird. Stocks are swinging about as though there’s a full-blown crisis, while the S&P 500 is just 2% from its high.

One way to measure the scale of moves is to look at sectors. The gap between the three best-performing sectors over six weeks and the three worst has rarely been bigger, and usually during some sort of panic. At least in data back to the mid-1990s, it’s highly unusual that sectors should diverge so much yet the index stay so stable.

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The last time the sectors diverged so much was just before Silicon Valley Bank’s collapse prompted a global banking panic and federal rescues. Before that was the rebound from the first lockdown low. And before that was during the global financial crisis of 2008-09 (earlier the dot-com bubble and its aftermath saw a series of bigger sector swings).

Those who just buy the market might not even have noticed anything strange. After all, the average stock in the S&P is flirting with record highs. This year, the S&P is virtually unchanged, while the energy sector is up 22%, boring consumer staples up 13% and financials down 4%.

The oddity shows up in the options markets too. The implied dispersion of stocks, how much they are expected to move relative to each other, is very high, as Tim Edwards, head of index investment strategy at S&P Dow Jones Indices, points out.

Dispersion of stocks has only once been higher when implied volatility, measured by the Vix, is so low. That was in October last year, when there was a rush for Big Tech and all manner of super-risky stocks popular with individual investors, before those trades went into sharp reverse.

What to make of it all? There are three ways to treat such a strange market: Ignore it, trade it or panic. It isn’t obvious to me how to choose between them.

Ignore it. Index investors have been fine, as almost every faller is matched by a winner. Sure, there are major changes under way, so maybe we’re headed back to the old days when smaller stocks and value stocks beat the market. But broadly the economy seems fine, so like a swan, the frantic paddling under the surface could combine with the index sailing on serenely.

Trade it. There’s big money to be made or lost betting on how the rotations in the market work out.

Will AI eat the software services industry? They make up most of the worst performers this year, with losses of more than 30% for stocks such as Intuit, AppLovin and Workday.

Trucking? C.H. Robinson Worldwide tumbled 15% in a day and Old Dominion Freight Line fell more than 10% from its high amid a (probably overdone) worry about AI cutting them out by linking truckers and shippers directly, but the former is still up 16% and the latter up 24% this year.

Is Big Tech wildly overspending on AI? Fund managers think so according to a Bank of America survey, and the hyperscalers are all down this year. Meanwhile, the places they spend the money soared, with Sandisk up 153%, Western Digital 72%, Teradyne 63% and Seagate Technology 54%. It’s a wonderful time to be selling stuff to data centers, but actually building them looks less attractive to investors.

Panic. There are kind-of sensible explanations for all the sector rotations, the big-to-small shift, the growth-to-value shift. But the mere fact of the swings is discombobulating for stock pickers, and could push risk managers to cut back overall exposure. This can hurt the market as a whole and trigger further falls, even though growth, earnings and so on seem undamaged.

History doesn’t provide a clear recommendation. Take those previous episodes where there were huge sector shifts. In 2023, stocks were down six weeks after the rotation. After the pandemic they soared as the government pumped in stimulus. In both the 2008-09 financial crisis and the years of dot-com boom and bust, major rotations could be followed by large gains or losses.

What didn’t happen is what’s happened so far to the overall market: nada. It’s weird, and that’s what makes it so hard to respond to.

Write to James Mackintosh at james.mackintosh@wsj.com